Cursed By Knowing The Numbers

Commercial real estate’s epic fall from grace in 2009 is well documented in this markup of RREEF’s 2009 Real Estate Investment Outlook and Market Perspective.

I love this technique—the analyst actually went back and marked up their 2009 forecast at the end of the year with what actually happened. 

The downturn in San Francisco and Seattle, two traditionally downturn-resistant markets, was greater than forecast.

Pricing dropped 40% from its 2007 peak, and is forecast to drop another 10% in 2010.  NCREIF property returns were the worst in NCREIF’s 30+ year history.

The big conclusion of the markup?  2009 was the weakest year since the 1990’s—remember SURVIVE TIL ‘95?   I wonder what the new mantra is…

They are predicting a quicker return to zero or positive returns in 2010 than for the 1990s downturn—driven by cash on cash returns—with income getting re-established at sustainable levels.

Employment growth is expected to turn positive this year, with below long term GDP trend growth until 2011—performance tracking below previous recoveries.

The big thing they didn’t talk about?  What will the real estate banking market look like going forward?  The guys that threw the gasoline on the fire in 2005-2007—Lehman, Merrill, RBS, and Bear—are all gone.

The bottom line?  Commercial real estate, once viewed as a liquid, appreciating asset with the ability to carry a lot of debt as you rolled over the tenant mix, is now back to occupying its traditional role as a bond-like income producing investment with an inflation hedge.

Posted by Ted at 3:24 PM | Permalink

Dr. Peter Linneman, once again--

"...if real estate pricing is on average correct, relative to alternative returns, it probably means that 50% of real estate is over-priced, and 50% is under-priced.  The question is: 'Into which half does your portfolio fall?'"

Alternative returns are roughly equal to BBB bonds, or 6.25 to 7.0%.  Real estate returns have two components--annual appreciation of ~2.5%, and 3.75 to 4.5% in current cash flow.  This implies a cap rate of 6% plus or minus 150bps.  This means you either put no leverage on a deal [current NNN assets] or high leverage if you feel confident you have an attractive pop in value at exit [hedgies working with OPM].

Posted by Ted at 2:00 PM | Permalink

is how John King describes San Francisco in his SF Chronicle Place column.

too true.

This image brought to mind Joshua Prince- Ramus' talk at TED about how the conceptual design process for this project developed.  I can only imagine the fun of trying to convince a banker to give me a hefty enough construction loan to successfully capitalize this deal. 

The structural steel premium alone has to be $100PSF. Staging? elevators?  At least the land residual cost would be cheap...I like the visual of jacking the museum pod into place, very cool.  Would love to develop one of his designs, my problem would be populating the capstack. 

I am all for architectural over-commitment, but remained cursed by knowing the numbers...

Posted by Ted at 10:22 AM | Permalink

The critical path, or flow of a project’s momentum, is always changing.

Know what the team’s next three milestones are, who owns them, and how close you are to accomplishment and acceptance.

Stay off the critical path—have your deliverables provided on-time, and in a way that is easily acceptable by who is taking custody for this delivering this solution from you.

If your solution is not acceptable to the next one in your project foodchain, you own the problem of making it acceptable.

Posted by Ted at 8:55 PM | Permalink

The economists at Schwab are calling for a recession.  Made me wonder, is this another case of economists calling 10 of the last 3 recessions?  Or is it really time to batten down the hatches once again?

Liz Ann Sonders gave three traits resulting in her conclusions:  a severe real estate crunch, oil price shocks, and an inverted yield curve.   The numbers, curse them, are not as bad as one thinks.

Real estate crunch--here is Macroblog's look at sales adjusted for population for existing and new home sales.

This shows we are back to 2003 levels in much of the country--not a severe crunch unless you bought a condo in 2005--and not yet in recession territory.

The real issue is that appreciation has gone away, and as a result, those of us in states with a real run up in housing values will not have equity extraction as the way to pay for that new Escalade. 

And investors in second and third tier locations need to look closer at their hold strategies in a flat or declining environment.  Does the fact that we have a demand shock in the condo market mean that we are in a recession?  Or simply that it will suck to feed that negative cash flow for a couple of years for that condo?

Oil price shocks are part of the cost increases we are seeing--2% a month is how I handicap it.  I feel a higher exposure to increases in labor costs and trade contractor OH&P than to fuel prices. The extra $30 a week to fill up that carpenter's Quad Cab 2500 is small compared to OH&P moving from 19% to 27% in my market.   Here is the oil price chart:

And now to the <strong>inverted yield curve

The Fed believes

"the shape of the yield curve that has historically been the strongest predictor of recessions involves an inverted yield curve with a high level of the nominal [federal] funds rate."

  They add 

"it is noteworthy that Australia, and especially the United Kingdom have had downward sloping yield curves for some time...Both economies, however, have continued to expand robustly."

So the Fed's read of the tea leaves indicates odds are that we may avoid a recession.

To me, the real question is how the economy shifts over from being fueled by the consumer and their home equity extraction to growth fueled by companies.  Spatial demand is now longer fueled by investors buying condos because the stock market stinks. 

The demand is now from companies increasing headcount and putting cheeks in seats at 210SF per. 

The demand for insanely great housing has dropped some as my projects are insanely hard to pencil right now due to higher costs.  I don't see the top line increasing, so I am am focusing more on utility--functional floorplans, tier one locations, and buildable design.

Posted by Ted at 5:25 PM | Permalink

All this talk about costs going up made me wonder.  My company has been improving property for almost 20 years, and although the $PSF number is creeping up, I wanted to understand where the exposure was.

We went back and sorted our historical construction cost data for our distinctive homes  to see what the relative weighting of the different trades were.  Our data base was based on the approximately $125M of distinctive homes we have developed or project managed over the last ten years. 

This is what we found:

Conclusion:  finishes are what you have to watch. The two single biggest variables are cabinetry and casework, and finishes.

And in our business, where the dream is sold from the finishes in, but built from the inside out, I start to understand why it is so difficult sometimes to keep these jobs on-time and on-budget.

Posted by Ted at 10:03 AM | Permalink