The New Geography of Jobs - Enrico Moretti

.
Three years into our economic “recovery”, we are seeing some areas booming, while others continue to falter.
Here in Northern California for example, the declaration of bankruptcy by the city of Stockton stands in stark contrast to the strong recovery of the Bay Area tech and bioscience nodes only 70 miles away.
The New Geography of Jobs, by Enrico Moretti of U.C. Berkeley, provides an excellent big-picture analysis of the increasingly divergent outlook for our nation’s cities and delves into the reasons why this disparity is likely to widen.

In his book, Enrico Moretti outlines the many forces behind the agglomeration of talent at innovation hubs; Entertainment in Los Angeles, Software in Seattle, Finance in New York, and Biotech in San Diego, Boston, and the Bay Area. Although human capital is the economic hope of our nation, our universities and colleges are not producing enough graduates with the skills demanded by today’s employers, and those with the right skills are increasingly congregating in innovation hubs with deep labor markets.
 
In explaining the phenomenon of Silicon Valley to my lenders in the 1980’s and 1990’s, I would get a copy of the Sunday San Jose Mercury News and show them five sections of employment ads. By the year 2000, the Sunday Mercury News help-wanted section was larger than today’s entire edition. I could show multiple job openings for the most arcane of technical specialties. Now that employment ads have moved from newspapers to the Web, the attractive power of a deep labor market is magnified. The Web spotlights the world’s innovation hubs and the multiple job opportunities in a location generate the excitement that attracts young talent graduating around the world.

Dr. Moretti points to several demographic trends that exacerbate the divergence of our cities:

1. As people become more educated they are becoming increasingly more mobile. People with advanced degrees are more likely to relocate than people with a four-year college education, who in turn are more mobile than people with only a high school diploma. People leave home to go to college and then often move again to attend grad school. This talent is not averse to moving once more to pursue a career.
2. More and more people are marrying within their educational strata. Social networking and computer dating offers greater choice to potential couples, matching those with similar life experiences and ambitions. Especially, people with advanced degrees tend to marry each other.
3. The more educated the women the more likely she is to continue to work after child birth.
4. Couples with dual careers tend to remain in those areas with the greatest opportunities for both the husband’s and wife’s careers.

In prior generations people followed jobs. IBM could tell graduates to move to White Plains. GE could tell engineers to move to Ohio. Now, companies are following the talent. Employers in search of innovative talent are compelled to move their operations to these innovation hubs, and then offer high wages and generous benefits to compete with other employers attracted to this same hub.

The benefits of these innovation jobs are wide spread: These high wages result in greater spending – raising wage levels for the unskilled and non-technical workers in the area. Dr. Morreti estimates high tech jobs have a 5-times multiplier effect which compares to a 1.6 multiple for a manufacturing job. This spending attracts the amenities that attract new talent: And so a virtuous cycle ensues at these innovation hubs. Meanwhile a brain-drain occurs in the rest of the country. Stamford, CT ends up with five times the number of college graduates per 1000 residents as Merced, CA.

Dr. Moretti also provides an analysis of former innovation hubs, such as Detroit and Rochester, which have lost the magic that had once made them great. To remain competitive, Moretti writes, cities, companies and labor need to embrace disruptive change; creative destruction is the source of economic vitality and innovation.

Highly recommended, a compelling read!

The Feds pledge: if at first you don’t succeed; keep making the same mistake.

Today the Fed Open Market Committee declared it would push the free market further out of balance.

Thanks to Fed actions and to problems in Europe, we are at historically low long-term interest rates; the yield on 10-year T-Bills is down to 1.64%. As if this is not enough, the FED pledged to extend the TWIST program using $267 billion over the next 6 months to exchange short term bonds for long-term bonds, to force long term interest rates still lower. The rationale? To stimulate the economy.


The Fed has used a horse-sized hypodermic full of monetary stimulus to get the economy up and moving, yet the US economy continues to lie still. So if that did not work, let’s give it another shot? Like the over-used quote from Einstein, “insanity is doing the same thing over and over again and expecting different results.”

Steroids hype short-term performance with bad long-term consequences. 

Shooting up the economic horse with low-rate steroids

The Fed policy of manipulating the free capital market with artificially low interest rates, may hype short term corporate borrowing, may save Banks from paying interest on deposits, deliver mortgages to those who can qualify, and even reduce the government deficit… in the long term it destroys the foundation of the investment sector; our pension funds, cities, retirees, insurance companies… it defeats the very motivation for long term investment.

The low-rate drug is not good for the economy; the side effects in the long-term are terrible; but the Fed keeps increasing the dose.

Besides the political pressure to “just do something!” what is the rationale behind this failed Fed policy?

The economic perspective of the Fed Board was shaped during the Carter-Reagan years, when interest rates were high, and lowering interest rates was an automatic, fast acting stimulus to the economy. Most of the stimulus came from two sectors; (1) the housing sector, and (2) corporate capital spending.

Now, despite years of low interest rates, the housing sector is still dead. So, let’s look at corporate capital spending.. In classic monetary policy; if you reduce the cost of corporate borrowing from say 10% to 8%, companies will start projects that return better than their 8% cost of capital, that were not justified at the10% rate. That’s the theory; but what also needs to be understood are the accompanying concepts of “payback-periods” and “corporate planning horizons”. A project that can return 10% per year has a 10-year payback period. If you are building a factory, a 10-year planning horizon makes sense.

But as the return decreases, the payback period increases.

Just like in the physical world, where physical properties change as temperatures approach absolute zero, so it is in the business world where as interest rates approach zero, normal business behavior changes. If corporate borrowing falls from a 3% cost of capital to 2%, the payback period for a project justified by these rates, increases from 33 to 50 years! This is beyond any corporate planning horizon. No company is going to make a 33-year bet let alone a 50-year bet.

The stimulus effect of the Fed’s manipulation of the capital markets peaked several hundred basis points ago. Shooting up the economic horse with more low-rate steroids, has gone beyond diminishing returns and is now only adding to the long-term negative side effects

Court decision threatens to turn non-recourse CMBS mortgages into recourse

.

An appellate court decision threatens to turn many existing CMBS mortgages from non-recourse to recourse.  It may take legislative action at each State level to fix it.

The commercial mortgage lending industry is abuzz over the December 27th, 2011 decision by the Court of Appeals of Michigan that confirmed a lower court ruling that Wells Fargo Bank as Special Servicer could pursue the warm-body guarantor of the non-recourse carve-outs for losses on a foreclosed conduit loan. The grounds? The failure to keep the borrowing entity, a special purpose entity (SPE) “solvent”.

Wait a second! Isn’t every borrowing SPE where the owner gives up and hands the lender the keys by definition “insolvent”? YEP! And, there was no argument on that fact in this case, by borrower, special servicer or judge. The judges finding: Standard CMBS documents have this SPE solvency carve-out and even though it makes no sense, the clause is not ambiguous. Be letting the loan go into default this carve-out was violated and the guarantor can be pursued for losses after foreclosure – despite the fact that both borrower and original conduit lender at the time the loan was created meant to enter into a “non-recourse” loan.

The loan in question was originated by Archon Financial (Goldman Sachs) and used standardized conduit documents. After successfully foreclosing on the property Wells Fargo Bank as special servicer brought suit to recover the deficiency under the non-recourse carve-outs. Amicus briefs supporting the borrower’s position were filed by the Mortgage Bankers Association, MBA, and the Commercial Real Estate Finance Council, CREFC. Even though this ruling will increase the recoveries on defaulted CMBS loans, it is bad news for the CMBS industry.

Scott Rogers, a real estate attorney at Rutan & Tucker, LLP, commented on the ruling:
"Cherryland may not only be bad for CMBS lenders, but bad for non-CMBS real estate lenders as well. The Court's strict and strained interpretation of some portions of the loan documents and not others resulted in an outcome that appears to defy common sense and defeat the parties' initial intent. Both lenders and borrowers must now be concerned that the implied intent of commonly understood provisions of their loan documents many years later may be wholly ignored or oddly reinterpreted by a court in unanticipated ways. This may lead to increased negotiation of loan documents, defensive drafting and yet further delay and expense in the closing process."

At Newmark Realty Capital, we’re seeing experienced borrowers becoming increasingly conduit-phobic. Many borrowers will only consider a CMBS loan execution if we demonstrate that we cannot solve their financing need with a loan from a life insurance company, bank or other portfolio lender. The Wells Fargo Bank vs. Cherryland Mall LP ruling will make these borrowers even more afraid to take a loan from a CMBS conduit.

CMBS loan closings will slow down

Legal bills to close a CMBS loan will get even more expensive. Borrowers should not try to save money on their own counsel. Borrowers must remember when negotiating a CMBS loan that they need aggressive legal counsel who routinely negotiate these somewhat standardized but evolving CMBS loan documents. Unlike loans from portfolio lenders, borrowers with CMBS loans live and die by the loan documents: As shown in the Wells Fargo Bank vs. Cherryland Mall LP case, once the loan is securitized, common sense, the party’s common intent or reality will not trump the language in the loan documents.

So if this ruling could be bad for CMBS lending why did Wells Fargo Bank, a major player in the CMBS, file the case?

Earlier this month, I attended the West Coast CREFC High Yield Debt Investment Conference (CREFC is highly geared toward the CMBS industry) and had the opportunity to ask the Special Servicing panel how frequently do they, as CMBS special servicers, take legal action against borrowers claiming non-recourse carve-out violations. Each panelist, representing LNR, CW Capital, PNC, KeyBank, Situs responded with “All the time!”
It seems a multitude of legal actions going at any point in time the norm for each of the firms. Specifically they all agreed that in the CMBS world it is the Special Servicer’s fiduciary duty to the trust’s investors, to find and enforce springing guarantees under the non-recourse carve-outs, as a means to maximize the recovery on a defaulted loan.

Newmark Realty Capital is involved in loan servicing for both life insurance companies and CMBS loan pools, and we see the CMBS world taking a very different approach to that taken for life insurance company mortgages, where lenders carve-out violations are used more as a threat versus a gotcha to get at springing recourse.

For more information...

The decision on this case is quite readable; you can find it here: Wells Fargo v. Cherryland Mall LP.
Here are some highlights:
“Defendants (borrowers) have argued, in the alternative, that even if section 9(f) (the requirement that the borrowing entity be kept solvent) was an SPE requirement, it was not breached. Defendants assert that the provision was intended to prevent owners from removing all of the money from Cherryland (The borrowing entity) , thereby leaving it without assets sufficient to pay its debts. And, because the owners did -not remove any assets in the three years predating the default, Cherryland's insolvency was not created by the owners and, therefore, was not a violation of section 9(f).
First, defendants do not contend that section 9(f) is ambiguous; thus, there is no reason to resort to extrinsic evidence to interpret it. Second, the parties agree that Cherryland became insolvent. Cherryland's only basis for its contention that section 9(f) was not violated is that the insolvency was not based on its own actions, but the downward spiral of the market. Section 9(f), however, does not require insolvency to occur in any specific manner. Rather, any failure to remain solvent, no matter what the cause, is a violation. . . . .
We recognize that our interpretation seems incongruent with the perceived nature of a nonrecourse debt and are cognizant of the amici's arguments and calculations that, if accurate, indicate economic disaster for the business community in Michigan if this Court upholds the trial court's interpretation. Nevertheless, the documents at issue appear to be fairly standardized nationwide, and defendants elected to take that risk—as did many other businesses in Michigan and nationwide. It is not the job of this Court to save litigants from their bad bargains or their failure to read and understand the terms of a contract. . . . . .
In summary, based on the rules of contract interpretation and the persuasive authority of decisions of other courts that have interpreted nearly identical loan documents; we agree with the trial court that the mortgage, as incorporated into the note, unambiguously required Cherryland to remain solvent in order to maintain its SPE status. Having admittedly become insolvent, Cherryland violated the SPE requirements, resulting in the loan becoming fully recourse. “

Time to wake-up the Great Sleeping Middle and end Too-Big-To-Fail

.
Where the Tea Party meets the Occupy Wall Street Movement
The power of Wall Street and a few mega-banks in Washington incenses the Tea Party movement on the right, and the Occupy Wall Street movement on the left. Both extremes demand that the Too-Big-To-Fail (TBTF) financial giants be curtailed. The right is incensed by the corruption of capitalism created by the bailouts and the Federal Government’s on-going involvement in propping up the big banks. The left is incensed by the failure of government to regulate for the consumer’s interest.

As voters we all feel insignificant compared to the political power amassed by the top 5 banks that were allowed to grow and control over half of all banking assets; both parties feed off their political donations. Congressional staffers and regulators feel productive as they regurgitate the legislation and regulations written by these banks’ lobbyists. Wall Street’s movement to “Occupy K Street” has succeeded for years.

The two political extremes agree that the United States financial system is broken and holds no promise of being fixed if the primary focus of the Treasury and the Federal Reserve is directed toward the health of a few mega banks. People on all sides are angry. Tax payers are angry about the bailouts. Retirees and savers are angry about a manipulated yield-curve that taxes savers and investors to benefit a handful of giant mismanaged or unmanageable banks.

The financial collapse of the Great Depression saw people marching in the streets to demand financial reform. That crises was not wasted. Meaningful legislation broke up banks, insurance companies and investment banks and curtailed the size of banks through interstate banking restrictions.

The anger from the current financial crises is being wasted.
Most of the regulations mandated by the Dodd Frank Bill are not even written yet and these rules are being crafted by regulators who are camped out with Financial lobbyists. (If you want to hear about the sausage-making going on to write the rules for the CMBS industry, give me a call.) Dodd Frank does almost nothing about TBTF. The “living wills” required of TBTF Banks under Dodd Frank will only work if a single institution falters in isolation. These TBTF institutions are too interconnected. Another major financial crises will hit all the big banks at the same time. This Too-Many-To-Fail (TMTF) scenario will force the government into another round of bailouts.

A voice from the middle
I am excited by the annual report from the Federal Reserve Bank of Dallas, “Choosing the Road to Prosperity: Why We Must End Too-Big-to-Fail Now.” This is not a political document written by extremists. It is an easily readable, persuasive argument from a frontline regulator. The message: TBTF is “A Perversion of Capitalism” “Capitalism requires the freedom to succeed and the freedom to fail.” Bank of America and Citibank were mismanaged and went bankrupt. When faced with its potential legal liabilities inherited from it Countrywide and Merrill Lynch acquisitions, BofA is probably still bankrupt. The Fed’s ongoing effort to throw profits to the big banks to earn their way out of insolvency has hurt the economic recovery.

We still need meaningful reform. Meaningful reform will require or incentivize the break-up of TBTF institutions. Dodd Frank does not do it. It is time to wake up the Great Sleeping Middle!

This is not another Dot-Com bubble

.
In 2011 Silicon Valley absorbed office and R&D space at a rate to rival all but the biggest boom years of the Dot-Com bubble.

"We’ve just had five-straight quarters of hefty reductions of available space and we’re not seeing any let-up in sight. In 2011, the Valley finally took off in terms of gross absorption, which translated into 27.9 million square feet for the year or a 28% increase over 2010. We had 30 new office/R&D deals above 100,000 square feet in Santa Clara County in 2011 and half of those were above 200,000 square feet. While the volume of large deals may not be repeatable, the Valley is poised to generate more net absorption in 2012, even with a little less gross absorption.”
Jeff Fredericks, Managing Partner in the Silicon Valley office of Colliers International, on Silicon Valley Trends 2012, Press Release 2/15/2012

Colliers’ forecast is for 27 million square feet of gross absorption for Silicon Valley in 2012, with six million square feet of positive net absorption. According to Colliers the vacancy rate in downtown Palo Alto for grade “A” office space is currently 0%. Office vacancy for Mountain View is in the low single digits. With the space being reserved by Apple taken out of the inventory, Sunnyvale’s office vacancy will also fall into the single digit range. Rents are up 30% to 50% in the strongest locations when measured to the depths seen after the credit crunch two years ago.

Are we in a repeat of the Dot-Com Boom? I put this question to several knowledgeable market participants; their responses are unanimous.

Kevin Catlett at Principal Real Estate Investors: “The current growth in absorption is amazing. We believe a key difference is that this time a lot of Silicon Valley’s growth is coming from companies with proven business models and real profits. Last time we had a boom largely based on VC funding; this time more of these companies are financing themselves from their own cash flow. ”

Geoff Hubbard, Research Director for the Silicon Valley office of Kidder Mathews: “The leasing data for the last 12 months shows that the largest transactions are by large, established, public companies such as Google or Apple. Google is pretty much taking everything they can in Mountain View while Apple is doing the same in Cupertino. With available space in Mountain View and Cupertino becoming scarce, they’re both expanding their footprint into Sunnyvale and surrounding areas.”
Google bought and leased 1.9 million square feet of space in 2011. To put this in perspective, this is three times the absorption of the entire San Francisco Office market in a good year. Apple is also grabbing space; if they complete the deals currently under negotiation they will have leased 1.1 million square feet in Sunnyvale in the last 12 months.

Chris Keith, Commercial Developer, at the Mozart Development Company lists nine reasons why this time it is different:

1. Corporate diversification and products within Silicon Valley markets is dynamic and broad with worldwide audience of product buyers.
2. Profitability is paramount and thriving (although I feel overall corporate growth and profitability will stabilize to a rational level, long term – stabilizing rents).
3. VC money is not available for unrealistic, unprofitable models. Venture money is being distributed wisely this time around.
4. Corporate profits and capital accounts are healthy.
5. For those companies that are marginal, costs have been cut, space shed, liabilities minimized, efficiencies realized - growth will occur slowly; if economic circumstances change most of these companies will not get caught with their pants down again.
6. For most firms we talk to current expansion is conservatively based (on current – 1 year growth) with fiscally solvent companies.
7. Shadow space and subleasing, today is almost non-existent.
8. Silicon Valley and surrounding area(s) will continue to attract the highest level of intellectual talent and corporate executives, managers, engineers in the world – the infrastructure has taken decades to build, billions spent by companies, cannot be easily replicated. To save costs support talent, manufacturing and assembly will be sent to secondary locations.
9. Silicon Valley specializes in the cutting edge technologies: The lowest price-point argument does not support intellectual property at inception.

Is this just a space-grab by the big profitable players?

There is definitely some of this going on. The leasing data is top heavy. But commercial property investors need to understand the changes in the typical business plan in the CEO’s desk of the average Silicon Valley start-up. It used to be: Get VC funding - Establish our value proposition - Go public with an Initial Public Offering. Now the typical business plan is to eschew VC funding as much as possible: Use funding from cash flow, customer partners, friends, family and angel investors. The exit strategy is not an IPO but to sell the company or product to Oracle, Google, Apple or Cisco.

These large companies have replaced the IPO option as the investor's exit strategy for much of the Tech world. Last time the growth in IT was reflected in lots of relatively small independent companies being housed by the commercial real estate community. This time these tech leaders are folding into the giants. Google bought 48 companies or packages of intellectual property in 2010 for $1.8 billion. In 2011 Google bought 79 firms or their inventions; I do not have Google total 2011 costs, but the the top three added up to $941 million. And already in 2012, Google's acquisition of Motorola Mobility at $12.5 billion was just approved by the EU and US Fair Trade Commissions. The appetites of Oracle, Apple, Cisco and the other mega players are equally impressive.

Will this pace of growth continue?

Phil Arnautou, Managing Partner at Colliers, worries that Silicon Valley’s current growth will be slowed down by the availability of technical talent. “The real problem is there aren't enough qualified people out there to fill the jobs to fill the buildings.”

Phil’s point drives home the other current theme of the Silicon Valley leasing world - it is all about the talent. Picking office space is no longer a tradeoff between rent and the distance to where the manager lives. Location decisions are both driven by, and constrained by how to attract new technical talent.
The next two years may see a slowing the Silicon Valley growth rate, but all indications are this is not a bubble, and this time it will not burst.

Why Silicon Valley?

.
What drives our local economy? What are the area’s competitive advantages?

In the early 1980’s I lead a bus tour of the area’s “Golden Triangle” for a group of British pension investors. The introduction of the PC was transforming information technology and Silicon Valley was booming My audience were board members who looked at the larger picture. I was thrown this question: “History shows that after the introduction of a technology the winners are usually the low cost providers. Why won’t this entire industry move to a cheaper location, like Austin or Asia?” Sure, I found words to come out of my mouth, but frankly, I was stumped.

Since that day, I've been an avid student of Silicon Valley. Yes, manufacturing largely moved out, but the headquarters and design functions stayed. Why? Local companies seem to thrive while many of the pioneers in other parts of the United States (Wang, DEC, Compaq, NCR) were acquired or disappeared. Why? The new-new-thing always seems to either start in Silicon Valley or move here in order to blossom. Why?

The Start-Up Story is Well Known: Silicon Valley has an infrastructure for innovation second to none.

In reality and in the movie, “Social Network” Sean Parker tells Mark Zuckerberg "take your company to Silicon Valley if you want it to get it off the ground".

A startup in the Bay Area can contract out all aspects of its development, including product design. Every category of engineer and scientist is here; willing to be lured by the chance to be part of an IPO. Most important the money is here: Bay Area’s share of Venture Capital continues to grow and is now approaching 40%.

The minnows need to be here but why do the whales swim in a Silicon Valley Pod? Not widely recognized is the transformation of Information Technology (IT).


There was a time when single firms (IBM, DEC, HP) dominated IT and could provide total solutions – like tall Sequoias reaching from the ground to the sky. These tall trees could be planted anywhere. Not anymore. Today IT solutions evolve through specialization, fragmentation, competition and collaboration, and have created a multitude of interdependent players, fast on their feet but needing to run as a herd. Sudden shifts in technological direction push established firms together to avoid being left behind. The goal is to anticipate a change of direction: Then do whatever it takes to keep up: Establish networks for intelligence, collaborate, imitate, and steal talent to keep up with the herd.

As such Silicon Valley consolidates its hold on emerging technology. If you are not here, you might find yourself isolated from the herd and vulnerable. Consider AOL and RIM Blackberry. AOL came back to Palo Alto. RIM is moving engineering here (though perhaps too late). Even Microsoft is growing its Silicon Valley campus, home to Bing.  Dell plans to double its Silicon Valley work force to 1500 employees in 2012.
Your collaborator today could become your competitor tomorrow, look at Apple and Google. In IT the old adage “keep your friends close and your enemies closer" still rings true, and in Silicon Valley it is truer than ever.

The world of Information Technology only needs one center. 
Perhaps the most important answer to "Why Silicon Valley?" is so obvious that it is often overlooked.
Fresh vegetables may need a local market for every few thousand people. The market for money has regional centers for each currency, and is united at two world centers, London and New York to accommodate time zones, currencies, tax laws and regulations.
The world of IT needs only one center. There is a single world-wide currency in IT, electrons, with only two denominations, Zeros and Ones. The Internet bridges time zones, languages and to a large degree outpaces regulations. To move a market center requires that market participants have a motive. Such a move will not happen; there is simply no compelling reason for another world IT center, besides Silicon Valley.

The half life of an engineer's education is 10-years and falling.
Why would a talented engineer join a major company at a location far from the center.  The Bay Area survives on its ability to attract the 20-something new talent from around the world and retrain the 30-something engineer whose specialty is no longer in demand.  Talent drives innovation.  In tech, old talent gets stale quickly and needs to be replaced with cutting edge new talent. The estimated half-life for an engineer's training is 10-years.  The Bay Area has the colleges, universities and institutes to offer continuing education for the 35-year old engineer who needs to be retreaded, but also attracts the fresh talent that brings the companies that foster more innovation that is taught in Silicon Valley first – a virtuous cycle. 
 

Why Greece matters

.
Google reported fourth-quarter revenue and profit that missed analysts’ estimates as an economic slowdown in Europe crimped international sales. Bloomberg News. January 20th, 2012.

Does it mean Google will take a little longer to occupy the 2,900,000 square feet of office space they leased or purchased in Sunnyvale and Mountain View in 2011?
And does it mean that after two years in the making, the effects of the European Debt Crises are being seen in Silicon Valley?

As an observer of the commercial real estate finance world and a commenter on the Northern California real estate markets, Greece and the whole Eurozone financial crises can seem very far away. Yet Newmark’s institutional investor clients and correspondent lenders tell me the consequences of this impending slow-motion train wreck in Europe is the biggest threat to the current relative stability in our financial world, and a force that could push a recession onto the entire developed world and seriously slow down the growth of the exporting nations of the developing world.

Some form of disintegration of the Eurozone is inevitable
Creating a united currency without a united government controlling fiscal policy may seem in hindsight to have been a really dumb idea. Countries hid their financial picture to be admitted to the Eurozone then almost immediately violated the guidelines; even on their own reported numbers that turned out in the case of Greece and likely other nations to be fraudulent. The solution being floated: We will now be serious about the guidelines that almost every country (including Germany) violated. We will centralize economic monitoring in Brussels and create penalties if countries violate the guidelines.

This solution is destined for failure, due to three reasons:
1. Unless there is a single European treasury, no one can trust the numbers. You have to listen to this investigation from NPR’s Planet Money. It details how a European Union (EU) accountant was sent from Brussels to Greece to calculate the true amount of the Greek deficit. The prior administration had claimed the deficit was 6% of GDP, the new administration claimed it was 12%. The EU accountant thinks this should be a one day task. He ends up being Mao-Maoed by the union leaders for the Greek Statistical Agency workers. He brings in reinforcements from Brussels and eventually estimates the deficit at 16% of GDP. His private email communications with his personal lawyer are illegally hacked. He faces strikes from the Statistical Workers Union and office occupations. He ends up being investigated by Greece’s Prosecutor for Economic Crimes for the charge of treason and faces a potential sentence of life imprisonment.
You can find the podcast here: http://www.npr.org/blogs/money/2011/12/16/143846133/the-friday-podcast-how-office-politics-could-take-down-europe.

2. Democracy is a process that is almost impossible to reverse. To achieve a common fiscal policy throughout Europe, the EU needs to take away a great deal of sovereignty from the member nations. Without free powers to set spending, to create tax policies, to set pension and retirement policies, member countries will feel like occupied nations; especially, if they face truly punitive sanctions.

3. Una faccia, una razza, as the Italians say, or mia fatsa, mia ratsa in the Greek equivalent, meaning one face, one race. There is a great cultural divide between Northern Europe and the Mediterranean region. The Mediterranean is a culture rooted in out-smarting its occupiers. For thousands of years, Greek and Roman history tells of small city-states dominating their neighbors and sometimes occupying whole regions. Areas like Sicily spent much of its history under foreign control by Greece, Roman, Vandel, Byzentine, Moores, Normans, Catalonians and Bourbon occupiers. Italy was not “united” until Garibaldi accomplished this by force, defeating the final holdout, Rome, in the 1860’s. If you talk to “Spaniards” from Catalonia or the Basque region, Spain is not united today. The Mediterranean culture is set up to use whatever leverage or subterfuge is available to benefit family first, village second and cultural sub-region third. National identity is far down the list. The idea of sacrificing for the cause of “Greater-Europe” might ring true in the North but not in the Mediterranean.

So if the Eurozone breaks apart, what are the consequences?
The threat of a Eurozone meltdown is real if not inevitable, but what are the consequences? Here things get murky. We face three negative outcomes that could happen in various combinations:

1. European Recession: This slowdown has started and will intensify: due to the need for governments to rein in spending, cut benefits, and raise taxes. On top of the headwind from this fiscal austerity will be increased austerity in the private sector as we see a need to deleverage in the European household, corporate and financial sectors.

2. Banking Crises: Last year, prior to the falling value of their sovereign debt holdings, European banks were estimated to need to raise 25% to 50% more capital to be properly margined. Those banks that did stock offerings in 2011 faced major reductions in stock prices in the last six months, now making it hard for the laggards to tap the equity markets. So if a bank’s equity is fixed, the main tool to improve capital ratios is to shrink assets; a bank’s portfolio of loans and investments. To meet most minimal of current guidelines, European banks will need to trim their loan portfolios by $3 trillion. The easiest way to do this is to stop making new loans. This credit crunch will cripple the European economy. To ease the process, European Banks need bail-outs, mergers and accounting gimmicks. But far worse than any lending constipation that results from the lack of bank equity capital is the potential of a financial panic caused by bank runs, or the modern equivalent – banks being cut-off from credit by other banks. To stem this contagion, the lender of last resort, the European Central Bank, ECB, is helping troubled banks with a European version of TARP (aka cash-for-trash). And, the Fed is helping the ECB. Without any approval from the American people or Congress, the Federal Reserve is helping to finance this effort under the guise of “a temporary U.S. dollar liquidity swap arrangement”, announced in December. This program will further balloon the Fed’s balance sheet and create a further flood of dollars in the world economy: Some are referring to this program as QE3. Let’s hope it works. In spite of these efforts, huge amounts of capital are moving within and also fleeing Europe.

3. Countries leaving or being thrown out of the Eurozone: There are many versions of how this could or should happen. The developed world has seen three fairly recent downturns caused by deregulation of financial sectors that turned into credit bubbles that popped. Two in Scandinavia, Finland and Sweden in the early 1990’s and the third in South Korea in the late 1990’s. In these cases devaluations of the currency were major factors helping these economies recover. Sweden devalued its currency by 34% and South Korea by 50%. The weak Eurozone countries could use this stimulus today but can’t because they share a common currency. I have heard it said that if Germany really wants to help Europe, they should be the one to leave the Eurozone not Greece. If Germany went back to the Deutschmark the rest of Europe can benefit from a devaluation of the Euro: Imagine the inflow of money created by cheap prime beachfront property in Greece and cheap labor throughout the Mediterranean.

Preparing for the consequences of a Eurozone breakup?

Here things are even less clear. One of the best analyses I found is “What Next? Where Next?” by David Rhodes and Daniel Stelter of the Boston Consulting Group.  In a nutshell, these experts say the European outcome is so cloudy you need to prepare for both deflation and hyperinflation scenarios.

2011 Bay Area Economic Engine:

.
Each year at this time I boil down the Bay Area business news into a summary organized by the Bay Area’s major industries and project their economic direction in the upcoming year. 



To download detailed chart click here!

Here's what I found:

In 2011 the San Francisco Bay Area continued its slow economic recovery with most sectors stable and some sectors booming. However the recovery is not even. Booming sectors are located in San Francisco, the Peninsula and Northern Silicon Valley. High-tech jobs account for 65% of the net increase in Bay Area jobs created this year, but high-tech is only 18% of the Bay Area economy. GDP for the San Jose, Santa Clara, Sunnyvale SMSA grew 13.4% in 2010, compared to the National average of 2.5%.

Silicon Valley’s 150 largest companies reported record profits in 2010 according to the Mercury News. These profits came with record productivity; $486,000 in sales per employee. Employment is up, but even in Silicon Valley and San Francisco, employment is not back to 2008 levels. http://www.siliconvalley.com/valley.com/ 

The East Bay and North Bay are stable but lagging.  The East Bay and North Bay often benefit from a spillover effect when Silicon Valley’s and San Francisco’s rents soar.  This is happening in apartments and beginning to happen in the office sector as well.  

Any dark clouds?  Yes, two:

1. Government employment and industries that receive government spending; education, defense, basic research and biotech. 
2. The Financial sector:  The IPO sector needs to come back for funds to begin flowing again into the VC funds.  A second financial crises stemming from the Eurozone threatens the big banks.  Small banks are struggling with real estate loan write-downs but extend-and-pretend has helped them as cap rates compression causes values to recover.  

In a nutshell:

Assuming we can dodge another world-wide financial crisis, the Bay Area’s economic outlook for 2012 looks bright.

Click Here to download the 2011 Economic Engine.

The Legacy Trap

.
What do a commercial property mortgage banker and a wealth management expert have in common? Both advise successful entrepreneurs on succession for their real estate legacy. And both bear witness to the sad consequences if estate and succession are not planned well, lawsuits that dismantle the family, mistrust and accusations that divide the children.

My colleague Rick Raybin, a wealth advisor specializing in cross generational wealth transfer and I collaborated on the attached article. In it we describe our different perspectives, and provide advice on how to avoid what we called the "Legacy Trap". A shorter version of the article was recently published in GlobeStreet.

Before it was published, I sent a draft to some of my clients who had experienced first hand inter-family lawsuits, families who had spent millions in legal fees, sons who took over the dad’s real estate business and found themselves ostracized by their siblings.  I received pages of heartfelt comments in response to the article and with approval, I put some of their comments in the sidebar. 

The article was written to help real-estate investors' heirs avoid the same fate, feel free to share.

Borrowers’ Biggest Financing Mistakes

.
This week I spoke at the monthly meeting of the San Francisco Real Estate Investment Forum held at the offices of Holme, Roberts and Owen, LLP.  The theme of my talk was Borrowers’ Biggest Financing Mistake.   

My advice to any commercial property investor... build a stable of seasoned “trusted advisors”; mortgage banker, leasing and sale broker, attorney, architect, accountant, etc.  Ask these advisors to trouble-shoot your plans before they are implemented - and particularly ask them about mistakes they have seen made by other investors, facing similar choices.

During my talk I shared a list of borrowers' common strategy and process mistakes, based on great input from twenty experienced members of Newmark Realty Capital’s loan production department. You can download the "biggest mistakes" list and presentation slides here.

"Experience is the name everyone gives to their mistakes". Oscar Wilde

The Fed promises to push our economy out of balance for two more years

.
The Board of Governors of the Federal Reserve issued a statement after meeting this week that the economic conditions are "likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013".
A free-market economy is an ecosystem.
Natural balances are reached between buyers and sellers, landlord and tenants, debtors and lenders.  Nature's ecosystems that suffer a shock can heal themselves with time: so could our free market economy if left alone from government meddling.  History has shown that when governments distort the free-market balance through price controls or other means, bad things happen. Watch out for unintended consequences!

Wage controls during World War II helped create our dysfunctional employer-pay health care system.  Totalitarian states of the communist era were famous for price controls that backfired.  Communist Poland wanted to give its population cheap bread and did so.  Eventually farmers were feeding their pigs bread instead of raw grain: wasting the efforts of the miller, the baker, the truck driver, the retailer and the energy to bake the bread.

unnatural balance

The housing boom was caused to a large extent by the Fed reducing the Fed Funds rate to 1% following the blowup of the dot-com boom.  The Fed has kept the Fed Funds rate set in a range of zero to 0.25% since January of 2009 as a response to the bust of the Great Debt-Driven Boom (see Capitalwisdom, October 15th, 2010). Now they promise to keep interest rates artificially low for another two years. If an organism or ecosystem is artificially contorted for four years straight it will not spring back. Expect the unintended consequences to last for a while!

What the Fed is doing is a form of price controls.

Keeping interest rates artificially below their market-clearing levels is a form of “Financial Repression” (See this month’s excellent newsletter from William L. Gross of PIMCO.  This financial repression is a hidden tax on investors and savers. If you talk to a group of senior citizens you will hear the rage and despair that comes from this unfair tax on savers. The Fed is sacrificing our retirement savings to send profits to the banks.

At the Fed’s Board of Governors meetings there is one member who consistently votes against this policy of extremely low interest rates; Thomas Hoenig, President of the Federal Reserve Bank of Kansas City. Mr. Hoenig points out that these low rates are having the opposite effect to stimulating the economy. Banks historically strive to make a 3% net spread between their loan yields and their cost of funds. Banks can make this yield today without making new loans, by paying near 0% to their depositors in interest and buying 10-year T-Bills yielding around 3%. Since they do not need to reserve for losses and do not have the cost of a lending operation, almost all of the yield from T-Bills is riskless profit. The banks lock in profits

and improve their capital ratios – a no-brainer.

Banks getting addicted to buying T-Bills instead of making loans to businesses: This is like Polish pigs eating subsidized bread instead of grain!

As happened in the last period of artificially low interest rates, Mr. Hoenig fears unintended consequences this time as well. He points out that bubbles occur when markets are out of whack. Investors desperate for yield do desperate things. He says he cannot name all the bubbles occurring this time around but he can point to agriculture land in his district that has tripled in value. Though low interest rates have helped the banks, the opposite effects can occur. Banks that lend against skyrocketing asset values, like Midwest farm land, will get hurt when those values fall. The Fed is setting up the next boom and bust cycle. See the interview with Mr. Hoenig at the PlanetMoney web site.
Since cheap money is not working to revitalize the economy, why is the government so keen to put its weight on the borrower side of the financial scales?

It may just be related to the fact that Uncle Sam is the biggest debtor of all.

Heads-up... don't set up your business in a way that is dependent on these low interest rates. At some point level heads may prevail and the Fed will allow the free-market to work. If that happens interest rates will rise to a healthy level and our financial system can achieve a market balance.

Silicon Valley in Transition

.
An interesting study was published this month on the workforce implications of the renewed growth of Silicon Valley’s cluster of IT industries, the Information and Communications Technology (ICT) cluster; networks, computers, chips, telecom, software, hosting, social media, etc.
For a copy of “Silicon Valley in Transition” go to  http://connect.one-stop.org/lmi/TechStudyFullReport_03.pdf

Here are the highlights:

• The ICT sector added 13,000 jobs in greater Silicon Valley (now defined to include San Mateo, San Francisco and southern Alameda counties) since 2009.

• The ICT sector is conservatively estimated to grow 15% over the next two years, adding around 20,000 new jobs.

• Companies are already finding it hard to recruit in certain engineering fields.

• Average salaries in the ICT cluster are growing again and now exceed $150,000/year.

• Silicon Valley is a magnet for start-ups and venture capital because of its deep pool of highly skilled talent. This talent in Silicon Valley is seen as more flexible and willing to adopt and learn the new technologies that cannibalize the old. Without “positive destruction” Silicon Valley would not be what it is today.

• Even as other tech centers have proliferated, Silicon Valley share of total US venture capital investment has steadily grown, now exceeding 40% of the nation’s total VC funding. The Valley’s “infrastructure for innovation” attracts companies such as Facebook to relocate here and companies such as Groupon and Wal-Mart Online to move engineering here.

• The reviving IPO market (Pandora, LinkedIn, and soon Twitter and Zinga will go public), is letting the local VC players cash-in, so Silicon Valley’s share of the VC pie is likely to grow further.

 

Dear Amazon, you have to be kidding!

.
This just in....
Amazon has filed a petition in California for a ballot measure asking voters to repeal the law passed in late June that was designed to force online retailers like Amazon to collect sales tax. Amazon will hire the firms that will collect over 430,000 signatures by late September to qualify the referendum for a statewide ballot on Feb. 7, 2012.

Paul Misener, vice president of public policy at Amazon, in a statement sent to journalists claims "This is a referendum on jobs and investment in California...."

Mr. Misener is correct. It is a referendum on jobs in California. Giving online sellers a 7-9% price-advantage over local California businesses, will shut down local businesses and will drive jobs out of California. If you need evidence, ask the19,000 employees at Borders. Borders was driven into bankruptcy largely due to this uneven playing field.

“It is in every Californian’s interest for online and store front businesses to play by the same rules," Betty Yee, first district member of the California Board of Equalization, said in a statement. "I strongly doubt Californians will support a loophole promoting out-of-state jobs, when holding Amazon.com accountable to the same rules as everyone else protects California’s economy.”

Let's hope so.  Support your local retailers who pay real estate taxes to our cities and collect sales taxes for both our state and cities.  Boycott Amazon.com.

See http://www.bizjournals.com/mobile/sanfrancisco/blog/2011/07/amazon-strategy-fight-california-tax-law.html

Time to boycott Amazon.com?

.
A key component of California’s 2011-2012 budget is to require online retailers to collect sales tax. Amazon is not taking this lying down and sent an email June 29th, 2011 severing ties with all its California affiliates (not me - "Capital Wisdom” has no sponsors or advertisers). Amazon is refusing to pay the tax and is preparing a legal challenge.

It is time for us to say, “Enough!”  And, we in the commercial real estate industry need to be the loudest voice. 

We, who make our living from the bricks-and-mortar industry, see the effects of an uneven playing field on retail tenants.  Our bookstore chains are dead or dying and our electronics stores are sick.  You can download a bar-code-reader app to your smart phone, stand in the aisle at Best Buy and with a few clicks, order that exact model flat-screen TV from Amazon, delivered to your front door and save tens or hundreds of dollars in taxes. 

Competition is great, but true competition requires a level playing field. 
Bricks-and mortar retail stores pay rent to our industry.  But more than that, they pay sales tax and property taxes to our States and local communities; they hire our young people; they sponsor our little league teams and support local causes and charities. 

You might think a bricks-and-mortar retailer could open its own on-line outlet and achieve the same benefit as Amazon.  No; they can only avoid collecting sales tax if they have no stores in that state. 

The consumer is responsible for paying its own sales taxes on on-line purchases.  A system that requires people to voluntarily tax themselves: How stupid is that?

Write to your Congress person
Tell them to pass legislation to require all on-line retailers to collect sales tax based upon the sales tax-rate for the zip code where the goods are to be delivered.   Tell Congress to ignore the screaming that “This is too difficult!” These are automated systems – it's not that hard to do.

When dot.com retailing started, the San Francisco Bay Area was a center of this activity.  At that time I supported a special status for these retailers.  Ignoring sales tax was a way to get this fledgling industry born.  

Amazon.com went live in 1995; it is now a 16-year old:  We have a powerful, self-centered and headstrong teenager on our hands. Time to grow-up.  Time to shop local. Time to boycott Amazon.com.

Why We Do Not Want Two Classes of CMBS

The multitude of Dodd-Frank regulators are working on the new rules for CMBS 2.0.  Built into the Dodd-Frank legislation is the concept of a Qualified Commercial Mortgage (QCM) - a mortgage considered conservative enough that no risk retention (aka Skin in the Game) will be required.  QCM Pools will have different players, different subordination levels and better pricing than CMBS bonds made up of loans that do not qualify as Qualified Commercial Mortgages.

I would like Congress and the Regulators to look at the QCM issue from 30,000 feet.   If they do, I am hoping they will agree with me that creating two classes of CMBS will cause more harm than good.

What is being proposed are two classes of CMBS “Prime” and “Less than Prime.” (Let's not use the phrase "Sub-Prime")
You may feel a sense of déjà vu: We saw this before in residential.

Two classes of CMBS is a mistake for three reasons:
1. It is not good for commercial real estate.
2. It is not good for portfolio lenders.
3. It is not good for the CMBS industry.

Let me take these in order:

1. Threat to Commercial Real Estate
Quality commercial real estate is not suffering from a lack of capital. Quite the contrary, we are hearing the word “Bubble” being thrown around again. Life Companies are slugging it out to win the conservative loan business.  What is lacking is capital for properties that, for reasons of location, product type or leverage, are not targeted by the portfolio lending industry. This is why we need CMBS to come back. QCM pools are a distraction for the CMBS industry. Creating a “Less than Prime” second category of CMBS will discourage funds flowing to where it is desperately needed. And when these funds do flow it will increase the cost of borrowing for owners of real estate largely ignored by the portfolio lending industry

2. Threat to Portfolio Lenders
When Ronald Regan was in office there were two classes of commercial real estate and commercial loans; life insurance quality deals, and S&L Quality Deals. Things have not changed. The life insurance companies are lending on the same quality deals. CMBS came in in the 1990's to fill the void the S&L's left. Having the CMBS industry now target Life Company quality business with a source of very cheap capital is an unneeded threat to a vital portfolio lending industry.  A low cost of capital killed the residential portfolio lending industry and could do so again in commercial lending.

3. Threat to the CMBS Industry
What we had in CMBS 1.0 was pretty much an undifferentiated securities product, with mortgage pools containing both the diamonds and the dreck. Removing the diamonds will not make for better mortgage pools. This new two tier CMBS system is not in the interest of the bond investors. The QCM pools will lack risk retention and will be created with very high incentives to force deals to be qualified as QCM. Subordination levels on QCM pools will be minuscule. I think that time will show that QCM pools will be anything but risk-less.

CMBS bonds made for Less than Prime pools will be penalized in pricing:  By removing the diamonds from the dreck the cost of mortgage loans for non-QCM product will be high and financing for this class of property might not be very plentiful.

Lenders' Views

.

Once a rising tide lifted all boats, but now lenders are looking for what they perceive are sure bets. So what are lender's current preferences? Apartments stay on top, with office bringing up the rear.

Apartments

Life Insurance lenders are beating the GSA's on good quality infill apartments. This could be because of where spreads are right now, but it could also be a political move on the part of the agencies. If the Tea Party wants to privatize FNMA-Fannie and FHLMC-Freddie, the best way to show a need for taxpayer support is for the agencies to be active where the private sector refuses to go, rural communities and C-Quality urban product. On the borrower side we are seeing active apartment owners rebuilding relationships with the life companies just in case the agencies are curtailed.

Retail

Lease provisions besides rent are more important than ever, effecting mortgage rates and property values. If owners are signing new or reworking old leases, they need to fight to get rid of co-tenancy clauses and to get annual reporting of retail sales. A mortgage rate might be 100 BP more for a big-box retailer without sales data versus a similar store where the owner can show the tenant has good sales performance.

Industrial
Lenders' adversity to single tenant deals is creating a big advantage for those owners who can do portfolio financings. Newmark Realty Capital has been able to get major discounts in interest rates for large industrial portfolios, say a single loan against 10 properties. With cheaper financing these larger players can bid higher for property to buy and bid lower rent to attract tenants to fill their buildings.
Office
Why, with 40+ million square feet of vacant office and R&D space in Silicon Valley, do we see major users designing campuses and leasing new buildings at twice the rent they would pay for a 1980's vintage R&D building? Partly tenants want safer more resilient buildings. To meet this resiliency demand from users the structural engineering profession is working on standards that will estimate a building's downtime after a major quake. ATC58 is in draft and should be issued in 2011. Just as important, tenants want spaces that can layout for the "office of the future", see my April posting.
Other Product Types
Newmark remains active in the outlying product types; self-storage, mobile home parks, data centers, hotels. If it generates income we can find a financing source, working with a wide range of lenders with a broad spectrunm of interests. We have a long list of life insurance correspondent lenders, are active in CMBS 2.0 and are also working with those banks that are back in the market.

To see the office of the future, watch how Tech does it

.
Micro cubes & bull-pens requiring multiple break-out rooms. 5.7 employees/1,000 SF and growing. A negative trend for office buildings – especially suburban stock.

San Francisco’s tech sector employment is approaching the highs of the dot-com era. See the excellent article by Casey Newton in the SF Chronicle.

But don’t throw a party quite yet
What strikes me is the shrinking use of office space on a per employee basis is erasing the growth in employment. San Francisco’s Tech sector is now down to an average of 175 square feet per employee or 5.7 employees per 1,000 square feet, with many companies cramming 10 employees into 1,000 square feet.

Why is this important?
The tech sector is the harbinger of trends in office use. This makes sense: Tech companies refresh their build-outs often, because they are either growing or collapsing. Tech employees are generally younger and more willing to accept change. These companies have already adopted the latest technology, so their office layouts show what is coming next.


 Zynga’s space (Desks 2’x6’, Cubes 3’x6’):

Photo: Liz Hafalia / The Chronicle

Take a good look at the photo of Zynga's office space...

What is making this possible?

Changes in Work Style
If you want to get a hold of a baby boomer, pick up the phone. If you want to talk to a Y-gen, send them an IM. In a phone-based corporate culture, 175 feet per employee would sound like a call center. These densities only work when people communicate electronically.
Richard Pollack, principal architect for the office interiors firm, POLLACK architecture, comments; “It’s becoming more prevalent in the young-person tech world that you shouldn’t even expect to get a quick response if you send an email to them! In fact, the current electronic communication approach is centered on social networking, even within companies. Salesforce.com released Chatter in 2010 which is their social networking tool for use by their clients and staff, and Google relies strongly on their multi-user collaboration tools known as Google Apps. Both companies are POLLACK architecture clients.”

Changes in Design of the Work Place
John Able, a prominent office leasing broker in San Francisco, told me the secret to maintaining employee satisfaction, with bull-pens and micro-cubes, is the provision of ample “Break-Out Rooms” available on an unscheduled basis. Densities of up to 10 employees per 1,000 square foot can only work by providing unassigned private break-out rooms, available when an employee needs to harangue a supplier, pitch a potential big customer, meet with a colleague or set up a date for the weekend, i.e. If you are going to have an extended conversation you head to the break-out room.
Richard Pollack also notes that beyond the Break-Out Rooms, a current design focus is to provide significant open collaboration space, with massage chairs, foosball, ping pong, etc. These spaces often incorporate white board walls (sometimes using special “white board paint”). Other trends are a lot of glass, and all the perks that we hear about – dry cleaning, dental vans (the equivalent of a food truck), etc.


Tech jobs up; space per tech worker down

Changes in Corporate Priorities

Rent used to be the top expense after salaries for the most office users. No longer - many modern companies are now spending more on IT than rent. According to the Corporate Executive Board benchmarks, the average company spent $8,910 per employee per year on IT in 2010. Software and Tech companies spent slightly more at $11,470 per employee per year. If a typical Tech company finds space today at $35/sf/yr full service in San Francisco, with only 175 square foot per employee, their rent is only $6,125 per employee per year, little over half of their IT budget.

What does this mean for office buildings in the future?

Clearly the design of office interiors is changing. But what is also changing are the metrics – Companies are focused less on rent per square foot and more on rent per employee. This change in metrics effects tenants’ location decisions. If you want to cram 10 employees in 1,000 sf then a typical suburban office building in a business park is less appealing. A tenant will accept a higher rent if that location allows them to achieve a high employee density. The typical suburban inhabitant is not going to tolerate this cutting-edge work-style, which is more akin to a college study hall or university library then the office environment of the baby-boomer generation. If you want to lower your rent per employee you need to be near Generation Y , i.e. hip and urban areas. You will also need a location where much of your workforce can come by public transit because the typical suburban office parking lot with a parking ratio of 4 cars per 1,000 sf of office space will be overburdened.



What does this mean for the recovery in the office sector?



As employment picks up, we will be fighting a trend toward less office space per employee. The recovery of the office sector will be delayed unless your office building happens to be in a Generation Y hot-spot: In my mortgage banking territory that is Palo Alto-Mountain View, Berkeley, or San Francisco.

The graphs and pictures for this blog posting came from the San Francisco Chronicle;  click here to read the article



Some good news for commercial real estate landlords and lenders

.
The Financial Accounting Standards Board and the International Accounting Standards Board have agreed to modify their proposed accounting rule changes that would have required balance sheet treatment for all commercial real estate leases.

The Incentive for Commercial Property Users to Lease-versus-Own Stays Intact.

The proposed changes to the FASB13 accounting rules would have jeopardized the current accounting treatment of operating leases by requiring all leases to be treated as capital leases, i.e. a lease obligation would show up as a liability on a tenant’s balance sheet. Read my blog post of December 22, 2010 for more details.
The real estate industry lobbied hard against this accounting rule change, with the ICSC (International Council of Shopping Centers) being especially active. The Mortgage Bankers Association (MBA) also weighed in heavily – and successfully turned around this controversial proposal.

Here’s the MBA’s recent report on the topic:

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards) have agreed to modify their controversial proposed accounting rules that would have required balance sheet treatment for all commercial real estate leases. The Boards have agreed to consider separating leases into two categories: financial leases and other-than-finance leases. Financial leases would be put on the balance sheet as an asset and liability and paid down over time. However, other-than-financial leases would be considered operating leases and would not have to be capitalized, which is the current accounting treatment for commercial real estate leases. MBA strongly supports the other-than-financial accounting treatment of commercial real estate leases. In addition, the Boards eased the standard for when lease option periods would have to be included in the lease value from “more likely than not” (over a 50 percent probability) to a much higher threshold.

Rebuttal to the Rebuttals to the Financial Crises Inquiry Commission Final Report

.
The Financial Crises Inquiry Commission issued its final report at the end of January. The commission split along party lines with the Republicans offering two dissenting opinions.
The dissenting reports do not dispute the facts of the crises. The key points of dissent boil down to how to answer these two questions:
1. Could knowledgeable people have foreseen the financial crises?
2. Could regulators have played an active role in heading off the crises or limiting its damage?
The Democratic members answer “YES”; the Republicans answer “NO”.
(The second dissent pins most of the blame on the government itself not for lax regulation but for its jiggering of the free market with government incentives for home ownership).
The Republican dissent casts doubt on the efficacy of regulation, i.e. Regulation only slows the economy and can have unforeseen consequences. No one saw this coming.
“Pro-Business” legislators tend to have a reflexive response, “Get the government as far away as possible and the free market will function best”. But are these pro-business politicians defending 0% - down, liar loans? That is the equivalent of advocating an unlimited speed limit on Highway 1 along the coast of Big Sur. People drove off the cliff? Really? No one saw that coming.

Support of free Capital Markets does not mean “no law” and does not mean “no policeman”
I am a great believer in free markets. As a young man (with hair), I was a big fan of Alfred Kahn and was able to meet with him in 1978 when he was deregulating the airline industry through the Civil Aeronautics Board. He is still a hero of mine. But, as a business person I quickly learned that market participants often conspire to keep their market from being anything but free and fair.

I respectfully dissent from the dissenting opinions.For some reason we feel that regulators must stay far away from financial markets. I disagree. If any other industry sold products known to be dangerous, that cost the public their fortunes, jobs and dreams – people would demand to see indictments and prosecutions and, if not, we would see public outrage and new laws. Yet, at this time, three years after Lehman’s demise – VERY LITTLE NEW REGULATION IS IN PLACE! The too-big-to-fail banks are even bigger.
The wisdom of our forefathers that separated depository institutions and investment banks was proven to be correct, yet in order to save the Investment Banks our government merged the two industries. “Financial Reform” has been kicked down the road by Congress to the regulatory arena – an arena dominated by the lobbyist of the Big Banks and Wall Street.

Many Cultural Myths about “free” financial markets need to be deflated...

“The Free Market Knows Best.” In our minds the free market is a buyer and seller each knowing the product, facing each other haggling over price: If a market is this direct and open, it works. To try to regulate it would allow either side to attempt to game the system. But, when the market is controlled by a re-packager and re-labeler of the product, who keeps buyer and seller apart so risks are hidden, watch out! IT IS NOT A FREE MARKET. It is a license to disorient and game both buyer and seller.

“In Time the Just Will Prevail.” The Wall Street vendors of CDO and Subprime-backed securities knew they were selling unsafe, if not poisonous, investments. The investment banks that survived were those who kept the least inventory or who bought more of the antidote (credit default swaps) than the companies that went toes up. The most cynical investment banks survived.
Why was AIG bailed out in the blink of an eye? They sold the antidote! Credit default swaps against these toxic pools of mortgage bonds.
Goldman Sachs, the clear winner in this debacle, designed and sold several CDO’s, in fact, 3 are within the top 5 highest default ratios. Goldman established a book-making operation taking bets on whether these products would default. They convinced their own clients to buy positions betting the bonds would perform. Goldman then reaped huge profits betting against their own bonds. Given how the mortgage pools were picked, a sure outcome. The SEC $500 million fine is a minor slap on the wrist given the magnitude of the profits made. (Goldman bet against the housing bubble, $21 Billion on Credit Default Swaps with AIG alone. We taxpayers made good on Goldman’s bet with AIG.)
When purveyors of dried milk added melamine and knowingly sold dangerous products to the people of China and the world – they paid the ultimate price – summary execution. And what happened to those who knowingly polluted our financial markets.

“These were Sophisticated Buyers Who Knew the Risks.” Who runs the investment desk at a company’s pension plan, union or government retirement fund? Generally not a sophisticated buyer. In the face of a commission-incentivized Wall Street Investment Banker that pension investor is cannon-fodder
“Only Fat Cats are harmed by Wall Street.” We know today, this is not true. We are all victims. This is everyman’s retirement money. Dreams melted into despair. We will each be working 5 to 10 years longer because our Government let this happen.
“All it takes is Full Disclosure.” So you read those inserts with your prescription medicine in 4 point type? They’re about the same. Wall Street lawyers are artists of obfuscation. With hundreds of pages of red herrings no wonder it is so hard to sniff out the real deal.
“The rating agencies are watching the store.” This myth needs no further deflation.

“The World of Finance is too complicated to regulate.” I’ve said before, nuclear power is complicated and we regulate that. Why? Because it can blow up in OUR FACES!
But finance is not that complicated. Ask a kindergartner:
What is a loan? If you lend a classmate a dollar, you expect him to pay it back.
What is loan underwriting? If that classmate is unlikely to pay it back, do not lend him the dollar.
Explain a credit default swap to a kindergartner? You offer a quarter to the friend of the kid to whom you lent the dollar, if he guarantees his friend will pay you back.
A derivatives’ market? You go to your fellow kindergartners and take bets on whether the borrower-classmate will or won’t pay his debt.

It is not that complicated. We need some common sense laws. And we need the government to police these laws.

Summary of the conclusions of the Financial Crisis Inquiry Commission:
http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_conclusions.pdf
Dissent Joined by Keith Hennessey, Douglas Holtz-Eakin, and Bill Thomas: http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_hennessey_holtz-eakin_thomas_dissent.pdf
Dissent by Peter J. Wallison: http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_wallison_dissent.pdf

For a lighter version the meltdown download my cartoon parable about the financial crises,” Mad Meat!”: http://www.scribd.com/doc/40224496/MAD-MEAT-September-2010