Trend Czar

How about a ride on a cigar boat?

Half the year gone--poof.

If you think, drivers are cutting back, the pleasure boat industry has been hammered even more. From my inlet vantage point with a view of all comings and goings from various marinas into Long Island bays towards the ocean, those comings and goings are relatively few and far between this summer. Late June--early July weekends normally pack the channel with watercraft--not this year. You've got to have money to burn under any circumstances to take out a cigar boat -- yesterday nary a one passed by to rouse the neighborhood in familiar jackhammer-like cacophony. And the local fishermen seem to be sticking to the docks and surf casting. Marina owners must feel a lot like greenfield suburban developers.

No doubt gasoline costs and energy will become top of mind campaign issues. The candidate worthy of support will map out a long-range plan to get the country out of its mess tied into restoring the nation's rapidly declining infrastructure, which contributes to more wasted time, delays, and costs. We need a New Deal style plan to build new airports, high speed rail, and mass transit, which all link together in our major urban areas, the so-called global gateways where most of our population now gravitates and where most of the nation's business takes place. Not only will a national infrastructure plan help ensure our global competitiveness, it could also put a lot of people to work. Local land use agendas need to tie into the national plan through tax incentives with emphasis on transit oriented development and high rise residential in and around pedestrian friendly urban nodes. We need to take a page from China and reserve 20-30% of our urban and suburban infill for green space--parks convenient to neighborhoods--so people don't have to drive everywhere to recreate. And we need to stop earmarks and funding programs--like tax increment financing--that allow local communities to build roads and sewer systems that perpetuate sprawl and cannibalize tax bases.

Even if we come up with the electric car or the no-carbon footprint car battery, greater self-sufficiency on energy will not solve our congestion crisis. We desperately need a more top down approach to land planning and infrastructure or all the talk about new solutions won't matter much. We're slated to add 100 million people to the country in the next 35 years and we will all be in perpetual gridlock, if we don't fix the system for how we will all move around.

Or we can just keep depending on gas costs increasing and sending more "foreign aid" to some of our favorite places like Iraq, Iran, Saudi Arabia, Nigeria and Venezuela. Our roads will be more potholed, but that won't matter so much. Highways will be congestion free--just like the ocean inlet.

Anyone need a cigar boat or a Hummer to drive to the marina?

Managing returns on the way down

Last night a bunch of former colleagues informally got together at a Grand Central watering hole to catch up. Most people seem to be doing well, maybe there was a bit more passing of business cards than normal. "It's time to keep your head down and work hard," someone said over the din and a beer.

Everybody expects performance to head south and there was some reminiscing about how pension fund advisors used to manage and massage returns on the way down in core real estate accounts -- avoiding anything too precipitous. One manager I knew of a decade ago had a bunch of bad properties with few good prospects -- somehow inevitable writedowns came in measured increments over six or seven quarters rather than all at once. The advisor apparently wanted to avoid the consultants' "penalty box" or rouse clients'  to withdraw or stop investing. Is that happening again? NCREIF returns are falling, but we still see appreciation registering despite cap rate decompression and softening fundamentals. There were a few wink-winks among the group at the bar.

Another former colleague in the fund management business said he has bluntly told portfolio managers at his company to be very careful in today's environment: "One thing you don't want is to be the last firm taking writedowns -- that will start to raise a lot of questions that you don't want to answer."

Appraising portfolios has always depended on rearview mirror assessment looking at recent deals -- managers use various combinations of in house and third party appraisers, who review properties at least annually, many quarterly, typically without site visits. It would be naive to think the process does not allow for some back room give and take, especially when transaction activity is fairly limited like today.

The dicey question now for many fund managers and their appraisers is to calibrate how low and how fast. Let's put it this way -- it won't be a straightforward calculation. But at this point in the cycle, managers won't win points for holding back if that's their inclination.       

80-90% Leverage

Just back from Toronto where folks seem considerably more buoyant than on the U.S. side of the border -- "that's what avoiding 80-90% leverage can do for you," said one banking executive with whom I visited.

Meanwhile, there were no takers for the $5 blankets on my American Airlines flight.

The recent consumer numbers have been better than we have any reason to expect. The tax rebates probably have been keeping people in the stores. But what's plan B? By now most of that money has been spent and gas prices keep edging higher. A retail analyst, I spoke with last week, was almost ready to capitulate -- "maybe they never will leave the stores," she said.  My response -- when all signs point to something, but it seems like its never going to happen, then you know it's just around the corner. Remember the tech wreck (those stock prices will just keep going higher) and the housing meltdown (housing values never drop)?

The big question on everyone's mind, what's going to happen with the CMBS special servicers. For years, observers wondered about how special servicers would handle a cyclical downturn with many defaults. Most loan documents call for dropping the hammer -- the dislocation between borrower and servicer and elimination of local bankers from the process, would probably mean more litigation and fewer workouts. So far, default rates seem muted as lenders and borrowers appear to be working together to avoid nasty headlines. But it's early yet. All the special servicers have a deep corps of legal teams lined up ready for action.  That's what 80-90% leverage can do for you. 

       

Slow motion crash

The commercial real estate markets are like one of the last cars in a chain reaction highway pile-up. We hear the noise up ahead, the red lights in front start shining in drawn out succession, we put on the brakes too, but we are too close and traveling too fast to avoid the crack up. Right now we are at that point of suspended animation where time seems to stretch out before the inevitable crack up.

Remember a year ago when it was just the housing markets that faced trouble -- that was the first collision, followed by the subprime mess, which took out several cars including the mortgage banks, followed by writedowns at the major investment banks, the Bear Stearns collapse, Lehman's troubles, various CEO ousters, and now more writedowns. Wall Street inexorably axes lots of execs and all the banks downsize -- its hard to get a fix on how many jobs, but the number of resumes flying around gets thick like ticker tape. The first real estate casualties were the dealmakers, who bought at frothy highs last spring, and the lenders who blindly bankrolled them. Hotels and malls start to feel the pinch of the economic downturn. Cap rates have edged up, as predicted, and now it's about time we see net operating incomes start to shrink as vacancies increase and tenant demand diminishes.

Today, the commercial property transaction markets resemble housing circa late 2006 when sellers thought they could still get top dollar and buyers were waiting for prices to fall. There's a transactional bid/ask disconnect and deals aren't happening. Buyers now get more certain that a fall is coming, and some sellers get more motivated. Once sellers capitulate, market values will start to track down and the correction will take hold. Then we'll start to see defaults and foreclosures bump up too.

If anyone thinks values and returns aren't headed down, let's hear about it. If you're a buyer and have cash, hold on. Good times lie ahead. Just fasten your seat belts in the meantime. 

   

Precious water

While the Midwest has too much water (poor Cedar Rapids), other places have too little, and the shortages don't necessarily result from climate change. Gov. Arnold recently declared a drought emergency in California. We've written before about how Las Vegas and other fast growing desert areas are tapping limited resources. Relatively fertile Atlanta and much of the Southeast remain on water restrictions as reservoir levels start sinking again, impacting a vast watershed serving farmers and commercial fishermen to the Gulf. A friend in Atlanta collects rain (when it rains and that has not been nearly enough lately) off her roof to wash the car and water the garden. Well, residents in Mediterranean countries like Greece have been doing that for centuries. And we may need to catch up.

Given expected population trends -- adding 100 million more people by 2040, some US regions may not be able to cope with the growth unless we change our ways.  In places like Arizona and much of arid Southern California, including the LA area, free flowing water will become more of a luxury as more people depend on it.  All those backyard swimming pools, stretching from Riverside to Manhattan Beach may turn into a major liability or else cactus gardens. The Colorado River watershed can serve just so many people, farmers and Las Vegas hotel fountains. Water restrictions and exponentially higher water bills will become the norm in these places.

Atlanta has been on a collision course with water shortages for several decades as it expanded into suburban subdivisions stretching well beyond the horizons: All those lawns to water and all those toilets flushing. Recent climactic changes (whether temporary or more permanent) push the entire region to the brink. Georgia has had no watershed plan, and fights with Florida, Alabama and now Tennessee over what has become a suddenly precious resource. We all take it for granted don't we? If the region continues to grow as expected, how can it possibly provide water to everyone without forcing people to conserve more?  Its Lake Lanier reservoir was within 40 days of running dry last fall and water levels are dropping precipitously again -- summer has only started. The only short-term bailout may be a major hurricane. In any case, a larger population would certainly put water supplies on the brink given existing (profligate) lifestyles.

That woman collecting water in her garbage can -- expect more of that, as well as higher water taxes and more severe development restrictions. The alternatives would be more dire.