Don Tishman's Real Estate Development and Investing Solutions

The failure of the House of Representatives to pass the Bailout Bill is causing more and more financial institutions to fail. Without financing real estate values will continue to plunge. 

 The fundamental issues have been  the capital inadequacy and the solvency problem of financial institutions with the root cause being the relentless deflation in real estate prices. Most people believed that the proposals by the Treasury Secretary would stem the deterioration of the financial institutions which in turn would stabilize real estate values.

Now this impossible to understand action of 135 Republicans and 95 Democrats is making every property owner in America lose significant values.

We most act to stop this roller coater of losing values right now. Here is the list of those who voted against this attempt to stabilize markets. Send them a message NOW ! Tell them to stop causing your property to lose value. . This is from:http://clerk.house.gov/evs/2008/roll674.xml

—- NOES    228 —

Thank you for helping every property owner in America-remember without financing who can you sell to? Only a few will be able to buy and they will dictate the sale price of your property!!!

Green office buildings cost more to build than non-green office buildings. Does this additional cost create enough increased value to warrant the extra cost?

We turned to the CoStar Group, #1 commercial real estate information company, in the U.S. and the U.K., for the answers.  The CoStar’s investigation started to compare U.S. based Energy Star rated office buidings and LEED-rated office buildings with a large sample of non-Energy Star rated and non-LEED rated buildings. As of late 2007, CoStar had in its database 893 Energy Star rated office buildings and 580 LEED-certified buildings. The Energy Star rated offices  included 322 million square feet of space.  The criteria for the  Energy  Star buildings used in this comparison is a Class A office building with 353,000 sq. ft., 15 floors, multi-tenanted,  and 91.7%  leased.  There were  643 Energy Star that met  the criteria and used in this comparison.,  while over 2,000 non-Energy Star buildings that met the criteria were used.  The LEED rated office buildings were not used because the data available did not differentiate between the various levels of LEED ratings.  The conclusions from comparing the Energy Star rated office buildings to the non-rated buildings were:

1. The occupancy of the Energy Star rated office buildings averaged 91% while the Non rated buildings were 87%.

2. The median rental rates for Energy Star was $31.50 per sq. ft., the  median rates were for non rated office buildings was $29.00.

3. 2006 Sales per sq. ft.for Energy Star rated office buildings was $350, for non-rated office buildings the price per sq. ft. was $260.

Based on the foregoing, CoStar’s study stated:  “This study provides preliminary evidence of higher valuations for green office buildings.”

How can a recently built structure be declared obsolete?  For example, in recent years, many multi-family developments were constructed without central air conditioning. As the summers approached, these apartments were very difficult to lease. These multi-family buildings without air conditioning steeply lost value. Their cap rates skyrocketed when it became apparent that these buildings were not competitive and therefore functionally obsolete.

Can buildings that ignore green building technology risk become functionally obsolete.?  An example of the absence of green building benefits that can cause a substantial loss of a building’s value is when the constant increases in utility cost make the combination of paying rent and utility costs more than the resident’s cash available.  Now resident’s income  no longer qualifies for living there.  This can significantly reduce the tenant pool.   With a diminished demand, the value will be diminished.

To maintain the value of your investment, your development must be designed to reduce utility bills. Make sure that the insulation ratings in the outside walls and roofs are higher than minimums specified in the local version of the International Building Code(IBC). Another is to provide an alternative energy source: Solar, wind, and geothermal are the most common.

If you are looking at an office buildings where the building’s exterior surface is glass, the utility bills are huge and will increase. Since this very high utility is paid by the tenant, it can be a deal killer when the owner are trying to rent space.   So before you make an offer for a glass office building, get bids for a remodeling that will lower utility costs.  Show it to the seller because this building is functionally obsolete, it has little value without these essential changes.  The amount that the seller will deduct from the sales price will depend on how badly the owner needs to sell and whether the seller or their broker verifies this essential remodel.   In any event, these repairs are an indispensable requirement for leasing these offices at market rates. You must keep current on sustainability requirements. Merely knowing L.E.E.D requirements is great, but this is not sufficient. Many of the L.E.E.D point awards while important, but are concerned with reuse of materials. Everyone has to consider the carbon emissions.

This a great explanation of why our financial markets are in crisis. This was sent to me by a highly regarded Chicago based commercial real estate banker, Bill Schlesser, of 5th-Third bank.    

Click here to view the Sub Prime Powerpoint Presentation

 The New York Times said on Sept.13th, ” that this drop in real estate values- is creating extraordinary buying opportunities for distressed properies” .  Regardless, there are no free lunches in investing.  The answer of how to buy these bargains with small amounts of cash depends on how diligent the investor is in doing the essential research: of the market, the building’s environment, and projection of future income. We will go over these necessary attributes in great detail.  

This is the time to buy not develop because you can buy today for far less than the you can develop for. 

First, these are the  components of real estate: land and existing uses, capital, users, and knowledge. The job of the investor is to provide the knowledge and and secure the other elements. How does the investor provide this knowledge? Is she or he the possessor of the total human knowledge of real estate investing?Hardly !!!  The investor is the coordinator. She or he must seek the knowledge from all available sources

The investor must start with a market study that shows the demand and supply for the use the investor is considering. 

First determine the market area for the proposed purchase.  This is usually restricted to a radius of 2 or 3 miles around the building in question. Much of the validity of the market study is correctly defining the market area. 

Demand Factors:

For this analysis, let us assume the investor is considering an apartment development. First who lives in the market area? Age, household size, and income. Employment is the generator of all types of real estate. There are two types of employment: those that generate sales outside the area and those that do not. Difference?

Studies show that for every person employed in businesses that sell outside the area two additional jobs are created in this area: while the local jobs create one additional job.  Later will be get into more sophisticated studies that will tell what motivates the target markets.   These cover a vast range of marketing segmentation systems that may effectively and efficiently identify your specific market segment, and show you the lifestyle behaviors and purchase preferences that drive their buying decisions.

SUPPLY FACTORS

Find the competition in the market area. What is each offering their residents? size of units, occupancy rate, rents, any concessions, number and type of parking provided, specific amenities in the units and also outside of the units. Visual impact of the proposed purchase Why are this important?

Some time ago, we were developing a 200 unit townhouse development in Indianapolis, Indiana. We  assumed that one other smaller development might also be developed.  To our astonishment, right after we started construction, there were an additional 1,400 multi-family also started construction in our market area. The market was absorbing about 200 units a year. This meant that if we all were able to rent up at the same rate, it would take 7 years for our development to rent up. By that time we could lose the development. We had made conservative cash projections for our investors based on an 18 month rent up period.  We researched what amenities the other units were offering to learn how we might clearly differentiate our units. We also figured how much this slow rent up would cost us. Most of the competing developments had as their amenity package an outdoor swimming pool and a clubhouse for their residents. One way to differentiate might be to add an indoor pool. In addition to the building and  pool cost, when we added in the cost of the equipment for maintaining  the temperature and humidity level of the indoor pool, it was close to our contemplated loss. We researched many other type amenities.  Finally, we agreed to build private cabannas around the pool.  As a result, we  were able to achieve rent up in less than a year. Going from a possible disaster to a success story. 

Differentiating your rentals from the competition is a corner stone of making $$$ in real estate.

We will be going into how to finance the purchase in this era of very tight credit. Where to find investors for your purchase? and the conditions that can make this a win/win for all.

One’s financial disaster can be another’s great opportunity. Look at the great fortune’s made by vulture funds when the commercial real estate marker collapsed in the 1990″s.  Sam Zell became a billionaire with the help of Merrill Lynch, who provided the legions of investors,  to fund his vulture purchases.   If you are focused on improving your financial condition, this may be your opportunity.

Home prices are down close to 40%, shopping center’s occupancy  has dropped to record lows. One recently opened mid-size shopping center in suburban Chicago, is signing up tenants rent free. Some 6,500 retail outlets have closed this year. Several national retailers have filed for bankruptcy. A superior office building in Manhattan at 42nd Street and Park Avenue sold for 40% less than what had been the market price.

Sounds like the 1990′s. You might ask why buy now, the market may get worse. I have been been a developer for close to 50 years,  I have observed that real estate is always cyclical. These sometimes last 7 years. For example, prices dropped in the early ’70′s. again in mid -80′s and then in the ’90′s. Eventually, almost all of the building sold in those bad times greatly increased in value. Ask Sam Zell.  The goal is to buy at the bottom of the curve and sell at the top. If you have the staying power, real estate values always return.

  What is the value of these buildings?  What is real estate value?  In income producing real estate, the value of the building is the value of its future income.  Your purchase price of a building is determined by the present income the building is receiving, not projections. If tenants are not paying, their lease has no value. If a lease will expire in a few years, this income must be severely discounted. 

You must research the seller and the building.  First, your broker must determine the urgency that the seller feels. This is like a spy story. The seller may have serious time constraints. For instance, in the above Manhattan office building, the seller was a Fortune 100 company that was moving its headquarters to another area. They had a short time line to do the move. They wanted an offer without contingencies from a buyer with the financial capacity to handle  a huge sale with or without financing. Today with the credit markets almost disappearing. This is a tall order. The buyer is based in London, and because of these conditions had a superior bargaining position.

Many properties are close to foreclosure. Time is of the essence especially if the seller has personal guaranties with the lender. In other words if the sale is for less than the outstanding balance, the seller would be liable for the difference.

This takes hard work- there are no free lunches!!

More in my next blog -where we will talk about what you have to learn to put yourself in a superior bargaining without the great wealth of the office building buyer. How to raise the funds for your purchase?

Things are looking up. The problem of obtaining home loans is being eased. The holders of more than 80% of U.S. home loans are back in business. The following is taken from an announcement by the Mortgage Bankers Association(MBA).

Today, the U.S. government took a historic step to stabilize the U.S. mortgage markets and financial system by placing Fannie Mae and Freddie Mac in conservatorship.

During a Sunday press conference by government officials, they announced these key steps:

Conservatorship

Fannie Mae and Freddie Mac are placed into conservatorship immediately.  (No change in status for the Federal Home Loan Banks.)

GSE(Government Sponsored Enterprise)  Portfolios 

To promote market stability, the GSEs will be allowed to increase their MBS portfolios through the end of 2009.  However, starting in 2010 the portfolios will gradually be reduced at a rate of 10% per year through run-off, eventually stabilizing at a much lower size.

Treasury Preferred Stock Agreement

Treasury and the Federal Housing Finance Agency (FHFA) have established a Preferred Stock Purchase Agreement to ensure that each company maintains positive net worth.  These agreements are intended to provide security to GSE debt holders and MBS investors.  In exchange, Treasury receives a senior preferred equity share and warrants to protect taxpayers – common and preferred shareholders will bear any potential losses ahead of the government’s senior preferred shares.

Secured Lending Credit Facility

Treasury has established a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.  This facility is intended to serve as an “ultimate liquidity backstop.”  This facility will expire on December 31, 2009.

Treasury Program to Buy GSE MBS

Later this month, Treasury will be initiating a temporary program to purchase Fannie Mae and Freddie Mac MBS.  Such purchases will be made as appropriate.  The program will expire on December 31, 2009.

Other highlights:

On Monday, the GSEs are expected to resume normal business operations.

The U.S. government assumes control over the Board and management.

Current Fannie Mae and Freddie Mac CEOs are being replaced, but will stay on through a transition period.

Herb Allison will assume CEO duties at Fannie Mae, until recent retirement the CFO of U.S Bankcorp. Formerly with Bank of America and Security-Pacific Bank. David Moffett will assume CEO duties at Freddie Mac. He was Chairman and President of TIAA-CREF from 2002 to 2008. Prior he was President of Merrill Lynch.

There will be limited initial management actions – they will work with the current management team.

There will be no dividends paid on preferred or common stock.

All lobbying/political activity by the GSEs will cease.

Next Steps:

Today’s actions have significant implications for the future of the U. S. housing finance system.  Clearly, there will be robust policy debates over the long-term structure and role of the GSEs.  In anticipation of these discussions, MBA will be working with its members to develop policy options that ensure an efficient and stable housing finance system.

Real Estate Market 

Today the media is reporting that the national residential real estate market has started to improve. Is this actually true?

In the May 2008 edition of Urban Land, Rachelle Levitt,  Executive Vice President of the Urban Land Institute in Washington, D.C.,  authored an article entitled Setting Priorities in Uneasy Times.  In this excellent, well thought-out piece, Levitt states that 2007 was a terrible year, and then compared 2007 to prior years:

            • Annual interest rates—1981=16.63%; 1990 = 10.13%; 2007 = 6.34%

            • Percentage increase in median home price:

                   1976-1981=74.3%; 1985-1990=28.9%; 1997-2002=30% 2002-2007= 30%.            

            • Existing home sales—1981=2,419,000 1990=3,147, 2002=5,631,000;                                            2007=5,652,000

Levitt then goes on to compare the current breakdown of the residential real estate market with the commercial real estate meltdown experienced in the late 1980’s, quite correctly attributing both catastrophes, in large part,  to certain lending practices.

 The recent failure of lending institutions to disclose the nature and extent of their losses from sub-prime loans at the outset cast great doubt on the credibility of their financial statements.  This resulted in a banking-industry scramble to recover credibility, either by completely suspending real estate lending or making the terms of their lending so onerous that few could qualify. And among those few who actually did manage to qualify for a loan,  even fewer would accept these unrealistic terms.

I lived through the breakdown of commercial real estate that lasted throughout the 1990’s. Fortunately we never borrowed from savings and loans. Our early experience revealed a general incompetence so glaring that it scared us off. S & L’s were making commercial loan, yet lacked any knowledge of the basics of commercial real estate practices. Prior to this, S & L’s only made home loans which they then turned around and sold to others, retaining the service fees.

 Regulation Q granted the S & L’s the right to offer higher interest rates for savings accounts than banks. This assured them of large supplies of money. When Regulation Q was later repealed by Congress, the S & L’s were faced with huge withdrawals. Desperate to stay in business, they started making loans on complex and sophisticated commercial real estate, bettering any offer the borrower might have been quoted from a bank.  The media attacked these S & L’s as crooks; in fact they were merely grossly incompetent and rather desperate.

It’s important to remember that all real estate markets are local. The existing inventory of unsold residences will be a significant factor in determining when a local market returns to normal.  For instance , some realtors in South Florida predict the present inventory will not be sold until 2012, while in Northern California, some areas see that their existing inventory has returned to historic normal levels. 

After this inventory is reduced, residential real estate will return to sound economic basis, only if buyers can obtain financing on reasonable terms. Lenders can not  accept loans for buyers who are not asked for their financial details. And certainly these loans will be not rated AAA by rating agencies.  Lenders must take the responsibility ARM that based on the borrowers income will put the home in foreclosure with any increase in interest rates. 

The public and private sectors will work to make a level playing field for all. Everyone isd then a winner