Cursed By Knowing The Numbers

The fall Urban Land Institute conference is a good way to get a gut check on the health of the real estate industry.

The impending green wave, coupled with cap rate expansion, gave me the distinct impression that the crowd was bifurcated into two groups--heretics and dinosaurs. 

Participants were either expounding the benefits of a greener planet--and acting dumbfounded why everyone else didn't see it, or you were thinking green--and LEED in particular--is a racket conjured up by a bunch of consultants.

What a lot of people didn't seem to see was that green offers a new way to crush an opponent when your asset is developed, operated, and positioned ethically and theirs isn't.

I mentioned to a couple of young Columbia MSRED students that I find the real estate industry is often the last group to realize an impending inflection point--too focused on making a cheaper buggy whip.  What an amazing opportunity for professionals just starting their careers. 

What is it going to take for the rest of us to get it?

Posted by Ted at 2:01 PM | Permalink

Condo guys sweating bullets,

Risk being priced as risk again--not opportunity,

Quality is king,

The dollar debauched,

Financiers explaining why the punchbowl went away, and 

Everyone trying to figure out whether "green" is risk in drag--or a new world.

Posted by Ted at 1:01 PM | Permalink

...again, taken from Professor Peter Linneman's talk at my ULI multi-family council meeting last week.

Every year, the US needs about 2 million new homes.  1.3 million to house the 3 million new people who call the US home, 100,000 second homes for these people, and roughly 600,000 homes to replace demolished or obsolete housing stock.

Against this demand, our housing industry produces anywhere from 1.4 million to 2.4 million homes.

Today, there are about 600,000 homes held in inventory--about a six month supply.  Builders hold 300,000 nationwide, the other 300,000 are being held by investors/speculators.  The surplus of 300,000 should work itself out--either by sale, or by investors handing the keys back to the bank--by 2008.

Some markets are so supply constrained, so in demand, that recovery is upon us.  To wit:

Posted by Ted at 7:40 AM | 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

What did I learn at ULI last week? 

Economy should hold up until after the election--limited demand growth in 2009-2010

Interest rates are 50bps higher than they should be to work off the excess liquidity injected into the system in 2002-2004 via lower interest rates.  Inflation in asset prices, and continued moderate inflation in the service sector

The echo boomers will soon be looking for homes--but a different type of housing stock will be needed.  Think Friends instead of Leave it to Beaver.  Urban, green, hip, with modern moves.

We don't have enough of this product to meet demand.

My favorite talk was by Prof Peter Linneman at the Wharton School of Business:

"the deflationary threat [of 2003-04] was not economy-wide, but rather limited to goods prices and rents, both of which were falling due to substantial excess supply...The low interest rates pumped money into the economy...service sector inflation rose by 100bps in less than a year...Realizing its error too late, the Fed pushed the short term rate higher...to sop up the excess liquidity.  The good news is that inflation is moderating..."

Professor Linneman went on to say that 60% of inflation comes from the service sector--and that the fed funds rate should revert to the current rate of inflation--250bps, plus a risk premium demanded by the investor, traditionally around 200 bps--around 4.5%.  He foresees a drop in the short term rate back to 4.5% by year end. 

Posted by Ted at 7:53 AM | Permalink

 Was at ULI this last past week, and listening to friends and participants there got me to thinking again about a triple bottom line approach to real estate development.

Majora Carter, in her TED talk last spring, articulated a triple bottom line for her projects. I am sold on this approach to recasting a property's land use, and I believe ULI can do much more in shaping how planners and practitioners understand what "best land use practices" really means. At this point, I need to get beyond the talk--4.9 million hits on Google for Triple Bottom Line--and get to the execution stage.

The question is how this affects my competitiveness--gaining control of sites, raising capital, executing on a plan.  Does including two other elements into the calculus of recasting property make me more competitive?  Or less?

My take on triple bottom line development is its value in perfecting a land use and its entitlements to create positive returns to the community, the environment, and those who build the asset.  The three "bottom lines" are:

1. Environmentally sustainable
2. Community enhancing
3. Rewarding to capital

The components of my projects are:

• Land Use
• Labor Utilization
• Return on Capital
• Quality of Plan and Execution
• Environmental footprint
• Community benefit

My goal is optimizing ROI's achieved from sustainable, community friendly development that have satisfactory returns to us and our investors.   Environmentalists embracing their inner capitalist, developers embracing their inner flower child, and politicos embracing their inner Jefferson Smith.

Environmentally sustainable is where I am seeing the most potential. Awareness of how to build in an efficient manner, how to use technology to produce more more carbon neutral assets, and use of the internet to offset your carbon footprint is becoming an integral part of our project planning. And sustainable technology, thanks to demand being induced in Europe, is really attractive.

Community enhancing is a little more ambiguous, as diverse communities have diverse needs.  Its mostly about seeing the bigger picture, creating crazy-good places where people who just love the area walk everywhere. Daily needs within a couple of blocks.

Posted by Ted at 2:56 PM | Permalink

...is typically a sign to me that we are approaching a market top, climbing that wall of worry.

A recurring theme throughout ULI last week was "Paranoid Optimism"--the idea that the future holds a number of low probability/high impact events, but the high probability/high impact of continuing low inflation, global trade, and a high rate of innovation means that optimism is warranted.

Bill Emmott, the former editor of the Economist Magazine, gave a ULI breakfast talk with paranoid optimism as its implied title.  The benefit of the pumping of global liquidity evidenced by a lower cost of capital  has a big multiplier effect--combine this with the internet driving a higher rate of innovation--the risks to a better global economy are political ones.  He believed there was a 50/50 chance of a US recession in '07, leading to a recovery right about the time the new president takes office.

His datapoints: 

• The 1993 global average inflation rate of 37% has decreased to 3% in 2006.
• The US two largest problems--a current account deficit of 7% of GDP, and a budget deficit of 3% of GDP are problems, but over-dramatized. A falling dollar will be the largest result of these imbalances.
• US$ has fallen 15% since 2000, and will fall further over the next several years.
• The Middle Eastern risk premium reflected in oil prices (currently $58/bbl) is falling and will fall further.

If politics and low-probability but high impact risks--terrorists with WMD, North Korea's collapse into violent civil war, or political instability and strife in China--do not strangle global trade and development, times should be good.  We have quite a tailwind at present.

George Soros is still looking for his crisis--the one predicted in his book failed to come to pass due to the pressure of global competition, increase in global labor supplies, low inflation and a high rate of innovation.

Emerging markets are now 50% of global demand--25% from China and India alone.

It is the politics behind the economics of a rapidly integrating global economy that are the risk.  It is how our societies adjust to the supply and demand disruptions that growth in labor supply bring.  It is how we price and incorporate environmentally friendly and carbon neutral development techniques into our best land use practices.

The environmental awareness and sustainability championed by Al Gore  in his movie are becoming more widely adopted.  The good news is that his ideas will eventually win--and his advocacy of carbon neutral lifestyles---the bad news is that he will not [be the next president of the United States].

The current "supercycle" of increasing commodity prices is due to twenty years of underinvestment.  Or rather undersupply caused by underinvestment. The current surge of investment in creating greater supply should reverse this financial commodity bubble.  The current 700 hedge funds working the commodity bubble has increased from 4 funds ten years ago, creating bubble conditions that will soon correct.

If the US does lapse into a recession next year, led by cuts in consumer spending, it is likely to be a mild one if interests rates stay low.Lower global demand by the US is likely to be counteracted by higher demand by Japan--now coming out of a ten year recession.

Posted by Ted at 8:45 PM | Permalink

One of the big events at ULI last week--standing room only--was the issuance of the 2007 Emerging Trends in Real Estate Report.  Based on surveys taken over the previous summer, the report is usually about six months behind for the markets I work in, but a good way to understand how people are handicapping the prospects of the global property markets.

Some of the more pertinent takeaways:

• Bicoastal preference--New York, SoCal, Washington DC, Seattle and San Francisco are the top five investment markets.  The Midwest sags.
• Multifamily preference--rising mortgage rates, expensive housing, and demographic shifts slot this property type back into the pole position.
• Niche Fever--will subside as the stock market and private equity funds provide alternatives for capital that last year looked at condo-hotels, assisted living, and resorts.

Emerging Trends Best Bets for 2007?

• Develop Infill and Mixed Use--in 24 Hour, Coastal, High Tech Centers.  Job growth is back in the Silicon Valley and Seattle.
• Focus on Management--no more cap rate compression to bail us out of overpaying for assets.  Protect future cash flows by working down expense levels.  Use green technology to reduce expense.
• Buy Homebuilder stocks.
• Build Green--reduce costs, and insulate yourself from utility company rate shocks.
• Sell the Dogs--Sellers have the upper hand, but the window is closing.
• Cap rates are anybody's guess...was shooting the breeze with someone from a major apartment investment firm and he was making the case that real estate should be a 4 cap business--25x net income--in the coastal, high barrier to entry markets.

Posted by Ted at 9:08 PM | Permalink

Stuyvesant Town and Peter Cooper Village, a 11,232 unit apartment property on 80 acres in Manhattan sold last week to Tishman Speyer Properties and BlackRock Realty Advisors for $5.4 Billion.

Gossip at ULI noted that in-place net operating income is just a little north of $110M with a close set for mid November.  The property's tenants bid $4.5B, one of twelve bids for the property.

These are the guys building the Infinity condominium project in SOMA here in SF--the first 656 of a total 1400 units in four towers are going up now.

This puts the going in cap rate at just over 2.  Obviously someone with a lot of money [and more successful than your host]  feels that cap rates are overrated...

Posted by Ted at 7:21 PM | Permalink

...I hate fashion victim architecture.  Moody starchitecture.  I just don't get it. The expansion of the Denver Art Museum, that is.

Played hooky one sunny day during ULI in Denver last week and went for a run to check out Daniel Libeskind's new extension to the Denver Art Museum</a>.  After reading Ouroussoff's review in the NYT, I had to see it for myself.  Does the "Bilbao effect" of starchitecture work if the building doesn't? 

Does the strategy of adding condos--clad in Rheinzink rather than titanium-- to the mix save this plaza from a windswept exile?

The sculptural aspects of the building were impressive from a distance. Titanium works well in the afternoon light. I can't for the life of me understand how it will be a great place for understanding art.  The arrival sequence is dehumanizing.  Form completely separated from function.  Lighting is tough with the sloping walls.

It will be a great space for a particular sub-genre of art--sculptor Antony Gormley's Quantum Cloud XXXIII, an abstract human figure made of sharp-edged metal seems right at home among the rest of the sharp edges. 

There is no other exhibit space I know of that has planes colliding into planes in the way this space does.

The number of acute angles may drive demand for art that responds to this angularity.  Was it a reaction to the surrounding buildings?

And for a building owner, the fact that titanium, besides being expensive, marks.  How do you keep this clean over time? They should have gone with the granite at ground level.

The detailing up close was disappointing--metalwork joinery was not up to the level of quality one would expect from a game-changing building, if that is what the museum's board members were after with the $110 million they spent on adding 146,000SF to the museum.  What else could have they been after?

The most interesting juxtaposition is how the acutely angular DAM expansion plays off Michael Grave's thirteen year old PoMo Denver Public Library.    A real architectural odd couple.  Now, I will be the first to admit that I am not a huge fan of master-planned environments, but will it be interesting to walk this plaza ten years from now. 

The real trick will be whether this structure adds to the life around it, or is a one-off stunt that sucks the life out of, and detracts from the art contained within Denver's arts center.

UPDATE:  Guess I was not that far off--

Posted by Ted at 6:44 PM | Permalink

Nothing like snow and freezing temperatures to get this whiny Cali boy going--and there was plenty to go on about.

I believe that Council participation is the single greatest benefit of ULI, and working shoulder to shoulder with these elaborately educated, type A personalities is often humbling.

I have been a council member for two years now, and am really appreciative of all the work that goes into these events. If you belong to ULI and are not on a council, get on one.The camaraderie brings out the best of ULI.

The councils focus on specific land use areas, and study best practices in each of these areas.  The councils get together twice each year for a day, and review recent deals, sharing ideas and perspectives.

We toured Stapleton, the ten year redevelopment of Stapleton Airport into a new community. The land takedown is staged, allowing Forest City to get greater land utilization. Infrastructure is paid for by a tax increment financing over the entire property, and development has been at a measured pace to maintain demand and pricing levels. There is a wide variety of housing available here in an infill location--the largest question from a community development standpoint is whether Stapleton's dependence on the Denver Public School system can be mitigated. The Gates Foundation is involved in the Science and Technology high school.

 
The second project tour of the day was Aero Flats  given by my friend, the wine-making, mountain climbing, real estate financier John Williams. John is the Managing Partner, Capital Markets for Carmel Partners, a group of perceptive, professional and principled real estate pros based in San Francisco. John has been instrumental in opening up opportunities created by Carmel to a larger institutional investment universe, and it looks like both groups have benefited.  This project was the successful renovation of a thirty year old property on the edge of Stapleton that used to be under the main flight path of the old airport

The third development we toured was 1600 Glenarm Place,  a redevelopment of an empty office building into an upscale highrise apartment community with great moves and  a well choreographed marketing campaign.

The property is in leaseup at some of the highest rates in Denver. The building was completely renovated to bring 333 units of rental housing into a great downtown location. Interior finishes were well designed, and well constructed.

The developer kick-started an upscale grocery/prepared foods store in the building, a very nice amenity for residents, but a land use that really needs training wheels to make it into a great neighborhood resource.

Fifty percent of new leases came from internet inquiries--foretelling a change in how we need to think about resident acquisition. A good management team, well executed plan, and a great asset.

Posted by Ted at 6:02 PM | Permalink