As I sit here looking out at the snow while I'm taking time out to review and update my goals for the year there are stars aligning to make the new year a positive one. Especially if you are looking for alternatives for your investment and retirement money. The stock market hasn't been good to us (I look at my account statement from between my fingers!) and the prognosis for the next year or two isn't much better.
In contrast there are a number of reasons to consider owning multifamily properties, specifically apartment complexes with more than 100 units. Before I go into the reasons why now is a good time let me first be clear about what I'm NOT recommending, the landlording business. The reason to focus on properties with more than 100 units is that they are large enough to support both professional management and professional maintenance; most likely having both onsite full time if not living there. As an owner of this type of property your job is to review the management reports and manage the managers, not unclog toilets or take phone calls from tenants.
Reason #1- Show me the money! The properties we're talking about produce cash flow in the low to middle double digits and total annualized returns in the high teens to mid twenties on five to ten year holding periods. Before you say 10% cash and 19% total a year doesn't sound like much let me be clear that we're talking about existing buildings with existing tenants and provable revenue, not dream stage tech start ups or land speculation in Vegas. Besides what are treasuries, money markets or even dividend stocks paying lately?
Reason #2- There are 100 or more people paying the bills for you. One of the things that make multifamily a good investment in tough times is the diversification of income streams for the property. As opposed to a rental house, or even a commercial building, strip mall, etc., no one tenant moving out will destroy your cash flow. A certain amount of turnover is expected and your professional managers will have a marketing plan in place to provide the necessary replacement tenants.
Reason #3- Good supply/demand characteristics. No one is lending on property development now, developers are shuttering any project not already out of the ground on construction and the number of new completions are dropping every month. There is some new supply on the upper end as condo projects are switched to rental (or being UN-condo-converted) but the multifamily properties we're interested in are the mid-level complexes that have good characteristics not top of the line luxury properties.
On the demand side there are three sources of tenants: Those who are renters by necessity because they can't afford to buy; Renters by choice who don't see the value in purchasing a home; Former homeowners who have been driven out of their homes because of the mortgage meltdown. For the 'B' properties, as they are called, there is an additional source of new tenants, 'A' renters moving down to reduce monthly expenses. B properties have most of the amenities of A properties but typically are a little older. Most were A properties when new and are in good neighborhoods which is also a factor that keeps B renters from moving down to C properties.
Reason #4- Competition for properties is low. While there a good deals to be had, especially from over-leveraged owners and bank REOs, most of the institutional money and foreign money is sitting on the sidelines waiting for the next upturn. Of course waiting for the upturn means that they'll be paying up for properties, maybe even for one that you acquire now.
Reason #5- Buy low, sell high. Prices in most markets have come off their highs and sellers are starting to become reasonable in their understanding of market fundamentals; they've been watching the same news reports as everyone else.
Multifamily pricing is often described in terms of 'Cap Rate' which is similar to the dividend yield on a stock. Buyers are demanding a higher return on their investment which means that Cap rates have been rising, in many places by as much as one to one-and-a-half percent. A one percent move in cap rate can mean a significant change in price. For example a 100 unit property selling for 3.5 million at a 7% cap rate would sell for just over 3 million and an 8% cap rate. We typically want to buy at cap rates of 8.5-10% or higher and are uncovering properties now in that price range.
Reason #6- There is money for apartments! Fannie Mae and Freddie Mac are being pumped full of liquidity by the government and while it's not publicized, they would MUCH rather lend that money on multifamily properties with steady revenue than on single family houses whose value may fall to the point where borrowers just walk away. Lending standards have tightened, which means that financially strong buyers have more opportunities and fewer competitors for the good deals. Commenting on the announcement that the Fed would aggressively buy Fannie and Freddie paper, even stock guy Jim Cramer http://www.cnbc.com/id/15838459 announced on his show that now is the time to buy real estate.
Reason #7- Interest rates are low and inflation is coming. Interest rates are being held as low as possible to stimulate the economy and multifamily borrowers can lock in 30 year fixed rates as low as 6%. At the same time the government and the Fed are printing and pumping out money as fast as they can and when that money starts moving through the economy interest rates and prices will rise. If you've already locked in a low interest rate you will be perfectly positioned to benefit from rising rents. Just think about it, fixed expense with rising income, just the opposite of having a job and paying bills!
Remember the multiplier effect of cap rates, every dollar per month that rents go up in a 100 unit property is $15,000 of additional value added to a property at an 8% cap rate, with fixed expenses. Raise rents 10 dollars a month and you've created $150,000 in value instantly.
Now is the time to get in at low prices with good returns on conservative deals before the big money and inflation start driving up prices on properties, that you own. Market selection, property selection and manager selection are all critical of course but in a tough market and in any economy short of dig a hole and crawl in with freeze dried food and crossbow, owning multifamily will provide both current income and positive growth.
Here's to a happy, healthy and profitable New Year everyone!
Giovanni Isaksen
Ashworth Partners Ltd.
www.ashworthpartners.com
Ask me about the Dealizer income property analysis tool.
Sunday, December 28, 2008
Thursday, December 4, 2008
The Bank Bailout Trap
We've cornered ourselves trying to bail out the "Too Big To Fail" banks. In trying to keep them alive in the name of saving the financial system we've been pumping them full of our childrens' tax dollars to little effect and we wonder why they're not really lending. The downward spiral of their balance sheets from both toxic assets and falling stock price continues but how to stop that spiral is being debated hotly in boardrooms, financial markets and congress.
What's preventing a solution from emerging is the "Too Big To Fail" trap. Until we recognize that these banks have already failed and we are throwing good money after bad we will continue pouring money down a bottomless hole. It's like lending 'grocery money' to a junkie. We can't allow ourselves to be held hostage by a handful of big banks.
I believe the only a comprehensive solution will get the financial system working again on a long term basis. Below are eight steps that are critical components of such a solution.
1- Place the insolvent banks into receivership now matter how big they are. This can be done by forcing failed banks to be split into a deposit bank and an investment bank preserving the deposit bank if possible and liquidating the investment bank portion.
2- The assets of these liquidated banks should be placed into Resolution Trust Company 2.0 (RTC) and sold off. The majority of these assets are mortgage backed securities (MBS) and credit default swaps (See 7 and 8, below for more). It's the proper valuation of these assets is the real sticking point. It has been reported that 90-95% of the loans in the MBS are performing therefore the loans in each may have to be broken out individually so that the good loans can be sold at a price that reflects their value. As an alternative a regulated trading market along the lines proposed by the Chicago Mercantile Exchange could be created to trade these securities with a minimum price set by the Treasury with the funds from TARP.
3- The cleaned up banks then can be sold themselves, with new management in place or come on board. If no buyers come forward for a particular bank it will be shuttered. The idea is that sales of the assets and the cleaned up banks will help offset some of the billions Treasury and Fed (read Taxpayers) have and will spend to save the financial system.
4- Glass-Steagall should be un-repealed so that banks cannot be in both commercial banking and investment banking. This is one of the most important lessons 'unlearned' from the banking crises that triggered the Great Depression. See my post Nov. 19 Entitled "Those Who Fail To Learn From History...".
5- Deposit (Commercial) banks will funded by deposit accounts, make only portfolio loans or loans guaranteed by a revamped Freddie/Fannie and be backed with Federal depositors insurance. The new Freddie/Fannie will only back loans originated by deposit banks and will carry the full faith and credit of the US Government which should (or be mandated to) keep loan rates below what is available on securitized loans which will not have govt. backing. Deposit banks will serve the needs of depositors and borrowers looking for secure institutions backed by the government.
6- Non-bank lenders and investment banks will have capital requirements and be regulated by a revamped SEC as manufacturers of securities. Their loans can be held in portfolio or sold in the MBS market. These entities will not be allowed to take deposits nor will they have any government protection beyond SIPC. The ownership of these entities will be restricted to accredited investors, institutions, mutual funds and ETFs.
7- Mortgage backed securities will be treated as securities and regulated by the SEC. The regulation needs to include provision for standardization of the contracts so that the mortgages contained in each are clearly stated and easily identified.
8- Credit default swaps (or whatever name given them), which are actually an insurance product need to be regulated as such and their issuance restricted to nationally regulated insurance companies with specific capital requirements.
Someone was quoted recently saying that any institution to big to fail is too big to exist and I agree, particularly when it comes to our financial system. That a few large banks getting caught with bad speculations can bring our (and the entire world's) financial system to the brink of disaster is confirmation of that fact.
We are also enduring the proof stage of an experiment testing whether human nature has evolved sufficiently since the 1920's to function long term in an unregulated financial system. Clearly human nature has not evolved and it is just as clear that our financial system needs regulation to insure it's integrity. A viable financial system should serve as the foundation of our dynamic economy but to do so it must be protected from our tendency to employ 'creativity' in the service of greed. The eight steps I've outlined above should be the starting point for rebuilding and maintaining that viability.
Giovanni Isaksen
Ashworth Partners Ltd.
www.ashworthpartners.com
What's preventing a solution from emerging is the "Too Big To Fail" trap. Until we recognize that these banks have already failed and we are throwing good money after bad we will continue pouring money down a bottomless hole. It's like lending 'grocery money' to a junkie. We can't allow ourselves to be held hostage by a handful of big banks.
I believe the only a comprehensive solution will get the financial system working again on a long term basis. Below are eight steps that are critical components of such a solution.
1- Place the insolvent banks into receivership now matter how big they are. This can be done by forcing failed banks to be split into a deposit bank and an investment bank preserving the deposit bank if possible and liquidating the investment bank portion.
2- The assets of these liquidated banks should be placed into Resolution Trust Company 2.0 (RTC) and sold off. The majority of these assets are mortgage backed securities (MBS) and credit default swaps (See 7 and 8, below for more). It's the proper valuation of these assets is the real sticking point. It has been reported that 90-95% of the loans in the MBS are performing therefore the loans in each may have to be broken out individually so that the good loans can be sold at a price that reflects their value. As an alternative a regulated trading market along the lines proposed by the Chicago Mercantile Exchange could be created to trade these securities with a minimum price set by the Treasury with the funds from TARP.
3- The cleaned up banks then can be sold themselves, with new management in place or come on board. If no buyers come forward for a particular bank it will be shuttered. The idea is that sales of the assets and the cleaned up banks will help offset some of the billions Treasury and Fed (read Taxpayers) have and will spend to save the financial system.
4- Glass-Steagall should be un-repealed so that banks cannot be in both commercial banking and investment banking. This is one of the most important lessons 'unlearned' from the banking crises that triggered the Great Depression. See my post Nov. 19 Entitled "Those Who Fail To Learn From History...".
5- Deposit (Commercial) banks will funded by deposit accounts, make only portfolio loans or loans guaranteed by a revamped Freddie/Fannie and be backed with Federal depositors insurance. The new Freddie/Fannie will only back loans originated by deposit banks and will carry the full faith and credit of the US Government which should (or be mandated to) keep loan rates below what is available on securitized loans which will not have govt. backing. Deposit banks will serve the needs of depositors and borrowers looking for secure institutions backed by the government.
6- Non-bank lenders and investment banks will have capital requirements and be regulated by a revamped SEC as manufacturers of securities. Their loans can be held in portfolio or sold in the MBS market. These entities will not be allowed to take deposits nor will they have any government protection beyond SIPC. The ownership of these entities will be restricted to accredited investors, institutions, mutual funds and ETFs.
7- Mortgage backed securities will be treated as securities and regulated by the SEC. The regulation needs to include provision for standardization of the contracts so that the mortgages contained in each are clearly stated and easily identified.
8- Credit default swaps (or whatever name given them), which are actually an insurance product need to be regulated as such and their issuance restricted to nationally regulated insurance companies with specific capital requirements.
Someone was quoted recently saying that any institution to big to fail is too big to exist and I agree, particularly when it comes to our financial system. That a few large banks getting caught with bad speculations can bring our (and the entire world's) financial system to the brink of disaster is confirmation of that fact.
We are also enduring the proof stage of an experiment testing whether human nature has evolved sufficiently since the 1920's to function long term in an unregulated financial system. Clearly human nature has not evolved and it is just as clear that our financial system needs regulation to insure it's integrity. A viable financial system should serve as the foundation of our dynamic economy but to do so it must be protected from our tendency to employ 'creativity' in the service of greed. The eight steps I've outlined above should be the starting point for rebuilding and maintaining that viability.
Giovanni Isaksen
Ashworth Partners Ltd.
www.ashworthpartners.com
Wednesday, November 19, 2008
"Those who fail to learn from history...
...are doomed to repeat it". Winston Churchill's advice is very timely because it seems like 60 years is about as long as we can go before having to RE-learn the important lessons from The Depression.
The repeal of the The Banking Act of 1933 (AKA The Glass-Steagall Act) in 1999 was the beginning of the failure that ultimately led us to where we are now. One of the big lessons that the Crash and Depression taught us was that banks who took deposits and made loans should be separated from investment houses so that problems on Wall St. wouldn't wipe out the whole financial system. When we unlearned the lesson in '99 the banks and Wall St. had a heyday of buying each other up in a rush to create 'financial super markets'. The idea was that once you came in to deposit your paycheck, they could sell you a few stocks, bonds, mutual funds and even some insurance.
Eventually we ended up with a couple of these huge financial institutions and the smaller regional players followed suite, merging and buying each other up to get big enough to stay competitive with the giants. Those from the Northwest may remember when Washington Mutual was a regional savings bank in the Puget Sound area and ran ads saying that they were your friendly local bank and would never do the bad things that the huge evil banks do.
Unfortunately the net result of combining low risk depository institutions with high risk investment houses is that the banks now had Wall St. risk and could be endangered by the very threats that we learned to keep them separated from. Worse yet, a handful were allowed to get "too big to fail" which meant taxpayers, open your wallets when the inevitable happened on the investment side.
The second lesson we unlearned was allowing the SEC to fail to enforce the rules against naked shorting. As far back as the Securities Exchange Act of 1934 speculators who wanted to make a bet that the value of a particular stock would fall had to borrow and have it in their possession within three days the stock that they were shorting. 'Shorting' a stock is the opposite of buying a stock hoping it will go up, the stock is sold first and bought back later theoretically at a lower price. For example ABCo is shorted at $100 and bought back later at $50. The profit is the difference less the cost of borrowing. Having to borrow the stock first meant that there was a limited supply of a stock and therefore speculators only had so much fire power in driving down the price to create their profits. When there is no limit on the amount of shorting that can be done to a stock, speculators can crush a stock or even a whole market sector. The SEC had the rules in place, but failed to enforce them. When this is combined with the next lesson un-learned the effects can and were devastating.
Unlearned lesson #3, the SEC repeals the uptick rule in July '07. Instituted in 1938 to prevent 'bear raids' by then SEC Commissioner Joseph Kennedy Sr. (Yes, the Kennedy dad was the first SEC commish partly because he knew all there was to know about stock manipulation). The 'uptick rule' was another rule limiting the ability of speculators to perform a bear raid (drive down a stock) by requiring the price had to move up at least a fraction before successive short positions are initiated. Since the repeal in '07 the S&P 500 has fallen more than 50%, certainly not only because of bear raids but the ability to pile on a falling stock clearly shows up in the volatility in the markets which has risen to all time highs in the last year.
I hate to use the word synergy in the negative but the combination of these three unlearned lessons built a huge bonfire under the banking system. Add the accelerant of the mortgage mess created by congress forcing Fannie and Freddie to back loans to sub-prime borrowers all that was needed was a match. The spark came from the crash of the securitized debt markets and woof! Up went the flames, down went the banks and trillions of our childrens' earnings were turned into tax dollars.
The problem is that banks, the heart of our financial system were allowed to stuff themselves full Wall St. speculations, when those 'investments' value declined the banks' balance sheets were damaged and that damage was compounded when speculators began their bear raiding, which further damaged the balance sheets causing them major shortfalls in the capital they are required to have. Even worse, because they are considered market savvy 'investment banks' they were allowed to leverage their assets three or four times more than back when a bank was a conservative institution for the preservation of depositors' money. Leverage is all good on the way up but it's a killer on the way down. So now as the downward cycle began their balance sheets were being eroded four times faster and there were no limits on the raiders.
With their assets (stock value + loan portfolio) disappearing unchecked it's no wonder that 'banks' don't have any money to lend, even the bailout money must go towards propping up the balance sheet. As Harry Truman said: "The only thing new in the world is the history you don't know"
Giovanni Isaksen
Ashworth Partners Ltd.
www.ashworthpartners.com
Ask me about the Dealizer income property analysis tool.
The repeal of the The Banking Act of 1933 (AKA The Glass-Steagall Act) in 1999 was the beginning of the failure that ultimately led us to where we are now. One of the big lessons that the Crash and Depression taught us was that banks who took deposits and made loans should be separated from investment houses so that problems on Wall St. wouldn't wipe out the whole financial system. When we unlearned the lesson in '99 the banks and Wall St. had a heyday of buying each other up in a rush to create 'financial super markets'. The idea was that once you came in to deposit your paycheck, they could sell you a few stocks, bonds, mutual funds and even some insurance.
Eventually we ended up with a couple of these huge financial institutions and the smaller regional players followed suite, merging and buying each other up to get big enough to stay competitive with the giants. Those from the Northwest may remember when Washington Mutual was a regional savings bank in the Puget Sound area and ran ads saying that they were your friendly local bank and would never do the bad things that the huge evil banks do.
Unfortunately the net result of combining low risk depository institutions with high risk investment houses is that the banks now had Wall St. risk and could be endangered by the very threats that we learned to keep them separated from. Worse yet, a handful were allowed to get "too big to fail" which meant taxpayers, open your wallets when the inevitable happened on the investment side.
The second lesson we unlearned was allowing the SEC to fail to enforce the rules against naked shorting. As far back as the Securities Exchange Act of 1934 speculators who wanted to make a bet that the value of a particular stock would fall had to borrow and have it in their possession within three days the stock that they were shorting. 'Shorting' a stock is the opposite of buying a stock hoping it will go up, the stock is sold first and bought back later theoretically at a lower price. For example ABCo is shorted at $100 and bought back later at $50. The profit is the difference less the cost of borrowing. Having to borrow the stock first meant that there was a limited supply of a stock and therefore speculators only had so much fire power in driving down the price to create their profits. When there is no limit on the amount of shorting that can be done to a stock, speculators can crush a stock or even a whole market sector. The SEC had the rules in place, but failed to enforce them. When this is combined with the next lesson un-learned the effects can and were devastating.
Unlearned lesson #3, the SEC repeals the uptick rule in July '07. Instituted in 1938 to prevent 'bear raids' by then SEC Commissioner Joseph Kennedy Sr. (Yes, the Kennedy dad was the first SEC commish partly because he knew all there was to know about stock manipulation). The 'uptick rule' was another rule limiting the ability of speculators to perform a bear raid (drive down a stock) by requiring the price had to move up at least a fraction before successive short positions are initiated. Since the repeal in '07 the S&P 500 has fallen more than 50%, certainly not only because of bear raids but the ability to pile on a falling stock clearly shows up in the volatility in the markets which has risen to all time highs in the last year.
I hate to use the word synergy in the negative but the combination of these three unlearned lessons built a huge bonfire under the banking system. Add the accelerant of the mortgage mess created by congress forcing Fannie and Freddie to back loans to sub-prime borrowers all that was needed was a match. The spark came from the crash of the securitized debt markets and woof! Up went the flames, down went the banks and trillions of our childrens' earnings were turned into tax dollars.
The problem is that banks, the heart of our financial system were allowed to stuff themselves full Wall St. speculations, when those 'investments' value declined the banks' balance sheets were damaged and that damage was compounded when speculators began their bear raiding, which further damaged the balance sheets causing them major shortfalls in the capital they are required to have. Even worse, because they are considered market savvy 'investment banks' they were allowed to leverage their assets three or four times more than back when a bank was a conservative institution for the preservation of depositors' money. Leverage is all good on the way up but it's a killer on the way down. So now as the downward cycle began their balance sheets were being eroded four times faster and there were no limits on the raiders.
With their assets (stock value + loan portfolio) disappearing unchecked it's no wonder that 'banks' don't have any money to lend, even the bailout money must go towards propping up the balance sheet. As Harry Truman said: "The only thing new in the world is the history you don't know"
Giovanni Isaksen
Ashworth Partners Ltd.
www.ashworthpartners.com
Ask me about the Dealizer income property analysis tool.
Friday, October 17, 2008
5 signs we're not heading into Depression 2.0
In a series of emails with Vince Farrell, CIO of Soleill Securities we were discussing his comments on CNBC about the contrast between 1929 and now. His point was that the policy decisions being made now are the correct ones and that there are a number of protections in place, as a result of the depression, that will prevent this recession from becoming a depression.
Briefly here are Vince's points that are both necessary steps to preventing depression and signs of hope for the future:
On World Trade-
Then: Smoot Hawley Tariffs enacted, result, world trade falls by two-thirds (66%!)
Now: During the last G7 meeting, members agree to "do no harm" in terms of protectionism.
Money Supply-
Then: Money was kept tight and the supply of money contracted by 33%.
Now: The Fed balance sheet has been doubled and they are flooding the market with liquidity.
Taxes-
Then: Taxes were raised to confiscatory levels, >60% on income as an example.
Now: Taxes are much lower except on corporations and need to be kept there.
Unemployment-
Then: There was no unemployment insurance and unemployment reached 25%
Now: There is insurance and the unemployment rate may reach 9%, or only roughly a third of depression levels.
Deposit Insurance-
Then: There was no insurance for the depositors, so that when banks failed (2,500 in 1933 alone) their money was just gone.
Now: Deposit Insurance levels have been raised to $250,000 on accounts including money market funds and most non-interest bearing business accounts have unlimited coverage."
If we as a nation, and our policy makers in particular can continue to remember the lessons from the past Depression 2.0 will turn out to be just hype and babble from the talking heads. It will be a tough recession and there are many serious structural changes needed but having been through a few recessions before I can report that each one looks like the end of the world when they appear; Now is a good time to tape Kipling's quote about keeping your head while others are loosing theirs to your bathroom mirror.
Giovanni Isaksen
Ashworth Partners Ltd.
www.ashworthpartners.com
Briefly here are Vince's points that are both necessary steps to preventing depression and signs of hope for the future:
On World Trade-
Then: Smoot Hawley Tariffs enacted, result, world trade falls by two-thirds (66%!)
Now: During the last G7 meeting, members agree to "do no harm" in terms of protectionism.
Money Supply-
Then: Money was kept tight and the supply of money contracted by 33%.
Now: The Fed balance sheet has been doubled and they are flooding the market with liquidity.
Taxes-
Then: Taxes were raised to confiscatory levels, >60% on income as an example.
Now: Taxes are much lower except on corporations and need to be kept there.
Unemployment-
Then: There was no unemployment insurance and unemployment reached 25%
Now: There is insurance and the unemployment rate may reach 9%, or only roughly a third of depression levels.
Deposit Insurance-
Then: There was no insurance for the depositors, so that when banks failed (2,500 in 1933 alone) their money was just gone.
Now: Deposit Insurance levels have been raised to $250,000 on accounts including money market funds and most non-interest bearing business accounts have unlimited coverage."
If we as a nation, and our policy makers in particular can continue to remember the lessons from the past Depression 2.0 will turn out to be just hype and babble from the talking heads. It will be a tough recession and there are many serious structural changes needed but having been through a few recessions before I can report that each one looks like the end of the world when they appear; Now is a good time to tape Kipling's quote about keeping your head while others are loosing theirs to your bathroom mirror.
Giovanni Isaksen
Ashworth Partners Ltd.
www.ashworthpartners.com
Saturday, October 11, 2008
Welcome!
Welcome to the new home of my blog where we can share and discuss insights about commercial real estate investments focusing on multifamily, self-storage and private residence clubs as well as our DEALIZER analysis software.
In the next few days, er, weeks I will import my posts from my former blog site.
In the next few days, er, weeks I will import my posts from my former blog site.
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