Friday, December 4, 2009

Buffalo Wild Wings Has Keys to Success

The Restaurant Association's performance index may show that the restaurant industry has been shrinking for the past 23 months but Buffalo Wild Wings (NYSE: BWLD) has continued to profit and expand, bucking that trend. According to new analysis by MSN Money, Buffalo Wild Wings tops the list of restaurants that are succeeding during this recession. It offers an atmosphere which contains both value based products and entertainment, perfect for the climate of negative news today.

This year, Buffalo Wild Wings has seen profits increase 34% and overall revenue increase by 31%. This growth is not contained to recent events, but in-fact has been a measurable trend. Over the past four years Buffalo Wild Wings has seen revenue growth of at least 19% per year. Last year it pulled in $422 million in revenues, by 2014 Value Line predicts yearly revenues to increase to $1 billion.

Expansion has been a key to Buffalo Wild Wings success. Currently it owns 197 stores and 363 franchises. According to its 2008 report, Buffalo Wild Wings aims to grow that number to 1000 outlets nationwide. In order to reach this goal, it plans on opening 60 stores a year. So far this expansion has been both achievable and profitable. Last year the company recorded revenues of $2 million per store.

Though many companies are finding it hard to maintain operations, let alone flourish in this economy, Buffalo Wild Wings has done so. It is always encouraging to look upon those that have managed to find success and companies such as Buffalo Wild Wings demonstrate that the correct business model can function in this climate. It also represents a rare opportunity to invest in an expanding business in an environment marred by foreclosures and bankruptcies. This is why we have seen a continued supply of Buffalo Wild Wings flowing through the net lease investment market, investors like profitable and successful companies.

Tuesday, December 1, 2009

Commercial Mortgage Defaults Rise to 3.4% in Third Quarter

According to recent reports, the commercial mortgage default rate on loans held in U.S. banks more than doubled in the third quarter, increasing to 3.4%. A year earlier commercial mortgage defaults stood at 1.37% and were at 2.88% in the second quarter. This development means that default rates are now at their highest levels since 1993.

Of all loans, those originating between 2006 and 2007 have experienced the most troubles, due to their typically high amount of debt financing.

Monday, November 23, 2009

Eight Restaurants Do Well While Market Falters

As reported by MSN Money, eight restaurants have done relatively well compared to their competitors and still have the ability to expand regardless of our current economy climate. Specifically, “all of these companies are financially healthy, with reasonable debt and the wherewithal to keep expanding despite a credit crunch”.

Here is the list:

  1. Buffalo Wild Wing Factory
  2. BJ’s Restaurants
  3. Chipotle Mexican Grill
  4. Olive Garden
  5. Panera Bread
  6. Peet’s Coffee & Tea
  7. P.F. Chang’s China Bistrow
  8. Texas Roadhouse

Calkain profiled Buffalo Wild Wing Factory (# 1 on the list) in our Net Lease Advisor.

Friday, November 20, 2009

Net Lease Insider Pulse: Richard Ader on Commercial Real Estate

Net Lease Insider interviewed Richard Ader, Chairman and Founder of U.S. Realty Advisors, LLC, one of the largest owners and acquirers of single tenant net lease real estate transactions. We asked him five questions dealing with the present and future of commercial real estate, his answers proved both insightful and thought provoking.

(1) Will the commercial real estate market bottom out in 2010?
I do believe the first six months of 2010 will continue to show a decline in value and rents in most sectors of the real estate market. I believe the commercial real estate market will start to bottom out in late 2010 or possibly into the first quarter 2011. A key determinant will be how the growing shadow of maturing mortgage loans is handled.

(2) Is commercial real estate’s fate tied to unemployment or any other pertinent economic factors?
Commercial real estate is tied to all economic factors due to the fact that real estate iscapital intense, and supply and demand driven. Job creation and unemployment directly impact all aspects of commercial real estate: vacancies impact rents for office buildings, and we assume that retail demand will continue at lower levels which will affect both retail and distribution properties. In addition, until the real estate capital markets are re-started, new real estate development is likely to remain at the current depressed level. In the background is the potential for increased inflation, which would impact the cost of operating properties and financing properties, but may not affect rents which are more demand driven.

(3) When recovery does begin, what areas will grow first and fastest?
I think the first areas to recover in the real estate market will be retail and distribution, with office being last. I believe when the recovery comes, people first will start shopping again. This pent-up retail demand will trigger distribution to meet greater retail demand (and permanent changes in retail patterns). Office space will trail the recovery, as companies will first re-occupy large volumes of currently unused space before starting to lease new space.

(4) Are there segments of commercial real estate that you find appealing even in this economy, including the net lease market?
We find net leases to be appealing. Like most real estate assets, cap rates today have increased substantially compared to the over-heated markets of two years ago, and lease terms are longer. There also are opportunities to buy mortgage debt at good discounts with the objective of owning the real estate or achieving equity-type returns.

(5) Would you prefer to invest: Close to home or in a stronger metro market? If yes, what are your top two choices?
I think the preference today for investments in multi-tenanted office assets should be in the stronger metro markets. Distribution should also be in the stronger distribution areas, and retail should be based on prior performance. Net leases should be driven by corporate credit. How the lessee uses the asset in its business and what alternate demand for the asset would exist if the lessee were to move out.

Tuesday, November 17, 2009

Sale of Detroit Pontiac Silverdome Sends Shockwaves

The Detroit Pontiac Silverdome, an 80,000 seat stadium sitting on 127 acres, has just sold for the titanic price of $583,000. It was sold to a Toronto based company at an auction held by the city of Pontiac, Michigan.

This is a remarkable statement for a building which once hosted the 1994 world cup and was home to the Detroit Lions (when they had Barry Sanders). It also is a harrowing representation of the current state of commercial real estate, shining light upon on an issue many know about but have yet to seen brought into daylight. Should the fabled "other shoe" finally drop off commercial real estate, could this prove to be the rule rather than the exception?

Wednesday, November 11, 2009

Commercial Real Estate Crisis Overblown Says One Industry Expert

Sam Zell, a “legendary real estate investor”, recently commented on the dire predictions attached to the coming commercial real estate crisis, stating that they are overly pessimistic. Specifically, he cited the cause for the current commercial real estate ailments as a “demand recession” but one not driven by drastic oversupply. According to Zell, there haven’t been major new supplies of commercial real estate since 2007.

However, he also notes:

“By 2011 and 2012, the lack of supply will fill those buildings. That's the good news. The bad news is that the buildings will be filled at very low rental rates -- so lenders won't get paid back."

Monday, November 9, 2009

CTL Financing and NNN Properties

By: Andrew Fallon

Debt financing, what debt financing? The capital markets remain dysfunctional, forcing borrowers to utilize alternative sources of capital. Fortunately, net lease property developers and investors can, and have been taking advantage of CTL financing.

Credit tenant lease (CTL) financing is a non-traditional type of commercial real estate loan that allows borrowers to “leverage-up” based on the predictable income streams of long-term leases. CTL financing provides substantial debt levels based on the credit-quality of the tenant, and the net lease structure securing the asset. The collateral is the long-term lease, not the physical real estate. Lenders are comfortable providing funds knowing that an investment-grade tenant’s monthly rent check will be paying the mortgage balance. Because CTL financing is based on the creditworthiness of the tenant rather than the creditworthiness of the borrower, developers and investors can access debt to build and purchase net lease properties, which continue to trade competitively in today’s market.

CTL can be a valuable source of capital given its key advantages over traditional financing. These advantages include maximum loan proceeds and lower debt service coverage requirements. CTL loans are characterized by their high LTVs (85% - 100%) and low debt service coverage ratios (1.10 – 1.25 DCS). If you are considering the purchase or development of a net lease property, then you might want to explore the CTL financing opportunities available for your tenant.

CTL recently in the news:

Walgreens Lending: A Victim of Its Own Success

Reinventing the Credit Market for Commercial Real Estate

CTL Financing Helps Large Deal Close

Monday, November 2, 2009

Retail Cap Rates Surge in the Third Quarter

Retail Traffic reports that retail cap rates surged during the third quarter:

“Average retail cap rates increased 59 basis points in the third quarter of 2009 to 8.71 percent, based on CBRE’s Valuation & Advisory Services (VAS) database. The 59 basis point gain is the largest quarterly increase the company has ever measured, edging out the 55 basis point jump recorded between the first and second quarters. Retail cap rates are now up more than 150 basis points from where they were in the second half of 2007.”

This information has some interesting implications. Cap rates have an inverse relation with prices, so we can alternatively read this article as saying that prices have dropped in the third quarter.

Lower prices could indicate that commercial real estate, retail in particular, could now be about to experience that long awaited and much dreaded crash it was predicted to have. If the trend continues at this pace, the retail sector could be in a lot of trouble very quickly. Alternatively, this could signal the opportunity many investors have been waiting for. Numbers such as these could, ironically, spur investment in certain locations as the perception spreads that the bottom is being hit. How this trend is affected by the coming holidays is going to be an interesting thing to watch.

Friday, October 23, 2009

Is the CRE Shoe Dropping?

By: Andrew Fallon

Recent CRE Headlines – Which Ones Should We Believe?
FDIC Frets Over CRE Loan Losses
3 Signs of the Next Real Estate Collapse
Is a Market Bottom Imminent?
Plan Coming on Commercial Loans
Commercial Real Estate Debt Won’t be the Next Shoe to Drop

So the commercial real estate market will be the next economic catastrophe but the market bottom is near, investors have amassed substantial acquisition capital, and the FDIC is getting ready with a plan. Will CRE be the next shoe to drop? No one is certain how this will play out and varying sources have varying opinions, but something must budge when $1.4 trillion of commercial real estate debt matures over the next three years.

As reported, those likely to budge will be community banks, many of which hold portfolios containing a large percentage of commercial real estate and construction loans. NREI reports that nation-wide, community banks hold roughly 11% of total CRE industry assets. To this point, FDIC Chairman Shelia Bair is encouraging these banks to restructure existing and maturing loans in hopes of avoiding or minimizing larger losses. Unless value returns quickly, community banks might be the next shoe to drop. That will sting, but does it mean that the commercial real estate market is collapsing, and what will the overall impact be on Main Street and the financial system.

Fear and history has everyone thinking about the residential mortgage meltdown and the widespread financial impact, but commercial real estate is a different beast. First, the majority of loans causing concern are construction and development loans, not existing buildings. Secondly, even though CRE property values are down, the underlying assets are/or have potential to be income producing properties, which can be value-add opportunities to capable investors. Lastly, there is a market for distressed commercial real estate (as opposed to second homes). Investors have been amassing cash and REITs have been raising capital to acquire many of these troubled CRE assets. According to a NREI survey, 70% of investors are preparing capital to acquire real estate assets indicating that some investors see great opportunity in commercial real estate despite the doom and gloom reports. Who are you going to believe and what’s your appetite for risk?

Thursday, October 22, 2009

McDonalds Earnings Go Up

McDonald's earnings rose 6% in the third quarter, posting earnings of $1.26 billion. Last year, same quarter sales were recorded at $1.19 billion and McDonalds expects this positive trend to continue.

Earnings per share also saw an increase, growing 10% to $1.15 from $1.05 a year earlier.

McDonald's success is a good sign for the net lease industry, as many McDonalds are structured as such.

Friday, October 16, 2009

Calkain Highlighted by Business Journal in Pitango Gelato Sale

Washington Business Journal's Tierney Plumb recently reported on the sale of the Pitango Gelato, located in Logan Circle's Metropole, for $618,000 ($1,123 per square ft.). The sale was brokered by Calkain Companies and represented "the highest square foot price that was attained to date". Assistant Vice President Rick Fernandez represented the seller.

Read the full article here.

Thursday, October 15, 2009

Is There Such Thing as a “Recover-less” Recovery?

This is certainly an interesting time for the economy and the world in general. After being rocked by one of the worst financial blows recorded we are seeing a mixed bag of results:

The Stock Market?

Up. Now hovering around 10,000.


Up. Now at 9.8% but as many analysts point out the real number is closer to 17%. It’s predicted to reach 10.5%.

CMBS Delinquency Rate?

Up. September posted a rate of 3.64% as opposed to .54% a year ago.

Home Foreclosure Rates?

Up. “As of last month, 7.58 percent of U.S. homeowners were at least 30 days late on their mortgages, up from 7.32 percent in July”.

U.S. Debt?

Up. It’s currently over $11 trillion.

There are no doubt numerous other indicators which should be thrown into the tea leaves but aside from the stock market it seems like we are in for a somewhat downtrodden recovery. The recession may be characterized as “over” but do most people really feel that way?

The term “jobless recovery” is thrown around a lot but looking at all these numbers, one wonders if there is also such thing as a “recover-less recovery”. If unemployment continues to rise, people will naturally spend less and more defaults will be observed. Furthermore, due to the large amount of debt accrued over the past few years, one would expect a lot of earnings to be dedicated to debt obligations, not current spending.

When giving out coupons for products businesses are often faced with the prospect of “borrowing from future sales”. They may increase sales numbers this month but next month they will go down. Collectively we did just that over the past decade, borrowing from future prosperity to have it “right now”. Naturally we are now experiencing the subsequent drought. There is nothing to really do; giving out more coupons (stimulus) only puts off the problem till later. That is why the recovery does not really feel like one. The economic growth that was supposed to sustain us today was spent yesterday.

Monday, October 12, 2009

Vacant Commercial Real Estate Reuse

There is an interesting article from Business Week detailing many creative reuses for our vacant commercial real estate. Some of ideas seem more probable than others (some seem crazy). Here is an outline of some of the highlights, organized from least crazy to most.

1. In the Realm of Possibility

Hydroponics in Auto Plants:

Many auto factories have been left vacant from the recession but may serve more agrarian uses. As Business week observes, “The open bay nature of auto plants and showrooms can provide the space for hydroponic and aquaponic greenhouse operations”.

Community (Kitchen) Gardens:

Turn that unsightly vacant lot into a veritable country landscape! Many old properties were demolished to make room for new properties, only to have the recession hit, forcing the projects to be abandoned. Residents are using the land the way our forefathers did, “Philadelphia has already implemented an urban kitchen garden policy and many other U.S. cities could benefit from one.”

2. Getting Out There

Farms In-Between Freeways:

You know those grass, sometimes tree covered medians? Well instead of dreaming about plowing your 4x4 over them when traffic hits, turn your thoughts to farming! “Freeway interchanges can be transformed into self-sufficient, positive contributors to cities…Converting the un-usable green gaps of the interchange to usable farm land is a win-win for everyone.”

Affordable Housing and Malls:

This one is sort of odd because we really don’t get the rationale behind the proposal. Here is the quote in full:

“Public housing has been decimated by the altruistic construction of mixed-income, mixed-use affordable housing projects throughout the country. Unfortunately these projects have, statistically, merely relocated the poor and working poor to inner ring, dying suburbs, with dying retail and little access to the necessary basic services that were centrally located in the original housing ‘projects’. Might it be possible to use dead malls for the basic services needed by these displaced citizens, and program the proximate houses, many in foreclosure, for true affordable housing, providing both access to basic needs as well as the seeds of a sense of belonging and ownership.

Instead of being placed by “dying suburbs and retail”, affordable housing should be placed in neighborhoods populated with foreclosed houses and near abandoned malls?

3. Crazy

Wind Harvesting Super Tower:

How would you feel about your house or apartment located right next to a wind harvesting super tower? “Erect large urban/suburban wind harvesting super tower units that occupy minimal floor space but can cleanly alleviate a percentage of community energy consumption.” At least there won’t be a bird problem, right?

4. Jack Nicholson Crazy


This is completely serious, someone did suggest the option you are about to hear. “Repurpose empty lots and/or structures to be used as landing stations for a system of small urban commuter airships. Clean transportation and a notable city feature.” Yes airships. Did you know they make a notable city feature? While we wouldn’t be opposed to having them, it seems like this idea belongs in an alternate reality universe. One without the Hindenburg.

In all seriousness, it is quite an interesting article and worth checking out.

Thursday, October 8, 2009

Retail Sales Exceed Expectations for September

Many retailers are quietly having a much better than expected month of September. Stores such as Kohl’s, Target, J.C. Penny, Walgreens, Family Dollar and Limited inc. (the parent company of Victoria’s Secret) all posted sales figures that met or exceeded expectations.

This is great news for the retail sector, which has been hit especially hard by the recession. If all goes well, September could actually post positive same stores sales, rather than ending in the red. If September same stores sales should drop, it will mark the first time this decade that the same month posted declines in consecutive years.

Tuesday, October 6, 2009

HSBC Agrees to Sale-Leaseback its Fifth Avenue Headquarters

HSBC has entered into a sale-leaseback with its American headquarters in New York for a deal totally $330 million. HSBC is also considering similar sale-leasebacks for its Canary Warf tower and Paris offices on the Champs- Elysees for $1 billion. HSBC plans on leasing the building for one year, and then lease only the first 11 eleven floors (the building is has 29 stories) for the following 10 years. HSBC has commented that this results not from cutting employees but from better utilization of office space.

This deal is not thought to be connected with HSBC’s recent decision to move its CEO’s office to Hong Kong. The buyer is a subsidiary of IDB group, a holding company owned by prominent Israeli billionaire Nochi Danker.
Sale-Leasebacks have become quite popular lately as more firms require an immediate inflow of capital to maintain operations. Another prominent example is a sale-leaseback with the NY Times building. Recently, even governments have been getting in on the act, as Net Lease Insider reports sale-leasebacks are to be undertaken by many U.S. State governments.

Monday, October 5, 2009

Confidence Crisis = Core Investments = Net Lease Properties

By: Andrew Fallon

The word crisis has been used in a variety of ways to describe the economic situation of the past 18-months. The National Housing Crisis. A Global Financial Crisis. Wall Street’s Capital Market Crisis. Banking’s Liquidity Crisis. This past weekend while attending a panel discussion on asset allocation, I heard a new term for the current stage of the crisis – the Confidence Crisis. The crisis terms listed above best describe what led us into the recession and the resulting chain-of-event reactions. The new term, confidence crisis, is important for determining the speed of recovery and how consumers and investors will be allocating their resources and assets. Promising surveys (WBJ) and reports (GlobeSt) have made recent headlines, indicating that investor confidence is mounting as credit rating agencies provide encouraging outlooks for retailers.

These reports are speculative because the confidence crisis stems from fear, lack of trust, and uncertainty, all of which are still very prevalent in today’s environment. As a result, consumers are conserving their discretionary spending, and investors are questioning where their funds can safely go to work for them. There is now more emphasis on wealth preservation and long-term hold strategies. This confidence crisis has highlighted the importance of core investments, which may not be sexy but can act as defensive holders of value.

Enter net lease properties, which attract investors due to the stable and predictable nature of a NNN property’s income stream. Net lease cap rates continue to creep higher, hovering between 7.00 - 8.00% in the NNN market, providing potential value add opportunities for core investment properties. Investment sales transactions are still taking place, although at a much slower pace than in 2007 - 2008. As the confidence crisis unfolds, complex high-risk investment alternatives are likely to be avoided and investors will be allocating more resources to core investments until confidence returns (and let’s hope we remember what this confidence crisis feels like so we can avoid it in the next cycle). In real estate investment terms, what’s more core than a single tenant net lease property?

Friday, October 2, 2009

A Tale of Two Industries: Residential and Commercial Real Estate

Private Residential Spending: Up 4.7% in August from prior month

Private Non-Residential Spending: Down 0.1% in August from prior month

Total Construction Spending: Up 1.1% from July

These numbers indicate that while residential real estate is recovering, commercial real estate lags behind. This could be due to a number of factors, including over supply and tighter credit. Currently the commercial real estate industry is expected to "continue its slump into early 2010".

For more, click here.

Thursday, October 1, 2009

Holiday Retail Sales & Outlook:

The fourth quarter is typically a time retailer’s look forward to with such glee that even a child would be hard pressed to match their level of expectancy. This is, after all, the time of presents, candy, costumes, decorations, ornaments and lavish meals. Children know Santa is coming to town and retailers know parents are. In-fact retailers are so anxious to begin this cycle of profits; they are often accused of putting out holiday items too early, the infamous “Christmas creep”. However, last year retail was hit hard by the recession; today the economy looks much the same and retail must adapt.

This will be the second holiday season celebrated under our current recession and the retail sector carries no illusions about that. According to a recent survey released by Hay Group, 72% of retailers predict sales this year will be equal to or less than sales last year and 57% are planning on reducing staff levels this holiday season. In comparison, last year 60% of retailers expected an increase in sales and only 29% decreased staffing levels. While these numbers are obviously negative, they are also prudent, reflecting a necessary change in mindset rather than an unfortunate change in the economy.

Additionally, retail is adopting new promotional strategies to better fit the current economy. 43% of respondents plan on “running more promotions and/or deeper discounts” this holiday season and another 43% plan to run promotions continuously from now till new years. This reflects a shift in focus from last year, when 45% percent of retailers ran most of their promotions on Black Friday (this year only 35% will), giving people more time to save up paychecks before making purchases.

These changes may already be having a positive impact on retails outlook. According to Fitch Ratings:

“Many companies across Fitch’s U.S. retail coverage have been managing inventory positions well. Gross margins have rebounded for those companies in the discretionary categories that were hit particularly hard during the 2008 holiday period. This, combined with strong cash flow management and the resolutions of liquidity issues for several companies, has resulted in an improved overall credit outlook”.

Though this may not be the holiday season of our dreams, it will certainly be a reality we are more equipped to cope with. Through tempering sales predictions, cutting overhead costs and altering promotional activities, retailers are becoming leaner and more efficient. Furthermore, in this current market where nearly 50% of net leases are traded as retail, should credit scores and sales improve, the only thing that may be going down are cap rates.

Tuesday, September 29, 2009

Moody's: Retail Outlook Improves As Holidays Begin

Moody’s has upgraded the retail sectors outlook from “negative” to “stable” over the next 12-18 months, though they remark that industry conditions “remain weak”. This positive change comes just as the Holiday season is about to kick in and reinforces the idea that retail will not have quite the discontented season as it did in 2008. For more, read Net Lease Insider’s insightful article.

Thursday, September 24, 2009

The Party is Over: Net Lease & the Future of Commercial Real Estate

In a very interesting article by Globe St’s Amy Wolff Sorter, the typical real estate investor of the future is predicted to be quite different from the one of our near past. Due to real estates most unfortunate bubble, the new investor will be squarely focused on pragmatic investments for the future, rather than “Real Estate Riches in 14 Days”. If true, it sounds like this “future investor” would be very interested net leases.

Specifically the article states:

“Experts tell that, in the wake of the 2008 economic crisis, the real estate owner of the future will undergo a seismic shift from the buy-and-flip investor to one that is knowledgeable about real estate and will stay with an asset for the long haul.”

This description perfectly fits that of a net lease investor. Net leases are primarily characterized by long term leases with stable tenants of investment grade credit. As such, net lease properties are generally considered to be low risk, dependable investments. For a marketplace suffering the effects of a hangover fueled by a lost weekend of high risk binging, net leases could represent that cool cup of tea and handful of Advil in the morning.

Tuesday, September 22, 2009

TARP = Successful…..TALF = ????

By: Patrick Nutt

The alphabet soup of government stimulus programs can be both overwhelming and somewhat perplexing, however it does seem we are finally seeing the results of the initial TARP program, and any bi-partisan committee will most likely tell you it worked (while then adding their political spin of whether or not they approve of the current or former administration).

No, the $350 Billion dollars pumped into the financial system to prop up banks did not help you or your friend’s sister’s aunt get that new loan she wanted to buy a vacation condo, but that was never the intent. What that program was designed to do, and accomplished, was to re-gain the overall confidence of the consumer in the overall banking system. Bank of America stock, trading at $2.50 just six months ago, has rebounded to $17.50; JP Morgan Chase was at $15.00 and is back up near $45.00. If these prices are any indication that the consumer is confident in the largest financial institutions in the United States, I would say TARP worked.

The Term Asset-backed Loan Facility (TALF) is an entirely different program aimed at thawing the frozen market for securities collateralized by consumer debt (such as credit card debt and auto loans), student loans, SBA loans, and now commercial real estate mortgages. The TALF program was announced back in November 2008, however Shopping center REIT, Developers Diversified (NYSE: DDR) is one of the first firm to actually secure financing through this program. DDR recently applied for and finalized the details on $2B in TALF financing….and here comes the interesting part, it’s not cheap! DDR is working with two investment banks; Goldman Sachs and Citigroup, to prepare the two issuances of debt. While all the details have not been made public, a board member recently commented on the basic terms:

Tranche 1
- Underwriters performed a 5-year cash flow projection
- Carved out 15% for additional vacancy and credit loss
- Applied a 9% CAP rate on the resulting Income
- Providing financing based on 30% LTV with an all-in cost of debt near 6%

While the cost of debt is attractive, the extremely low leverage point constricts the assets being used to either debt free or nearly debt free. What happens if you want more leverage you ask???? Well DDR asked for more debt with the second batch of properties valued at $1B and here is the result:

Tranche 2.
- Underwriters performed a 5-year cash flow projection
- Carved out 15% for additional vacancy and credit loss
- Applied a 9% CAP rate on the resulting Income
- Providing financing based on 30% LTV with an all-in cost of debt near 6%
- For the debt component covering from 30% to 35%, the cost of debt is above 11%
- For the debt portion increasing leverage from 35% to 40%, the cost of debt is around 13.5%

As you can see, if you need a higher ratio of debt, it becomes cost prohibitive very quickly. While this solution worked for DDR to help shore up their overall portfolio and deal with some of the smaller debt maturities, this is clearly not the answer to the $700 Billion dollar problem formerly know as the CMBS market circa 2003-2007.

Friday, September 18, 2009

Does “Green” Construction Affect Net Lease Investments?

By: David Sobelman

Calkain recently published the first of its kind report on environmentally sensitive (“Green”) construction for net lease investments. We found there are obvious benefits for everyone involved in a transaction. The argument from the development community has always been that the costs for building green building do not justify the benefits. However, it has been proven that the proper use of materials and education allow for a green building to be constructed at the same costs, or less, than conventional methods. Additionally, tenants may begin to require green buildings as their costs of operations will decrease and the social stigma of occupying green buildings develops into more of the mainstream. Lastly, landlords and investors will enjoy the benefits because most green buildings qualify for tax breaks and the intrinsic value of the asset will be more marketing in decades to come.

I think it is a proven fact that there WILL be changes in construction requirements as time goes on and more people begin to realize the benefits of green buildings. Some tenants have already begun occupying prototype locations and they are gaining in popularity among various users. See more about this topic at

Thursday, September 10, 2009

It’s the Loans, Not the Land: The CMBS Refinancing Crisis

It seems to be a generally accepted fact that Commercial Real Estate is about to hit the ground like a ripe watermelon thrown off a ten story building. Stories abound about how its impending collapse will send systemic shocks rattling through our weakened economy, delivering a rude kick to the face just as it is trying to get up. Investors stand quivering on the sidelines and banks are trying to find out how they can hire Jimmy Stewart (aka It’s a Wonderful Life) to perform some crowd control once their money evaporates with the popping of this last bubble.

And you know what? These predictions, dire as they are, may not be totally off base. If recent reports are to be believed, things are not all well with the world. The delinquency rate for CMBS rose to 3.14% in July, which is more than six times as high as the level last year and by 2012, $100 billion of the $153 billion worth of CMBS loans (65%) will face difficulties being refinanced. With this kind of information, it’s easy to see why so many are pessimistic.

The thing to be remembered, however, is that this is all the result of massive artificial inflation. There is nothing inherently wrong with the land; there is nothing inherently wrong with commercial real estate. There was something horribly wrong with the way people behaved between 2004 and 2007. Essentially, taking a Louisville Slugger to the figurative credit piñata and declaring “come get it!” resulting in drastic overpricing and horrible loans. The land itself was the innocent victim of this all and today faces the repercussions of our malfeasance.

In-fact, the cash flow from most of those properties whose loans expire in 2012 is enough to “pay interest and principal on their debt”. Even in the midst of this deep recession, commercial real estate is still producing wealth. The problem is that its values have inevitably fallen from their inflated highs, making it almost impossible for borrowers to extend their existing mortgages or refinance with more debt. But is this necessarily a bad thing? Clearly the market was flooded with bad credit, so is it wise to take out more debt, or in the case of government action, tax payer funded debt, to refinance bad loans? Perhaps it is best just to let the market clear itself of its toxic waste.

We collectively went on a binge of epic proportions and today have to face the consequences. But we never destroyed or devalued assets, we overvalued them. When the dust settles it will be found that commercial real estate is still a great investment, still capable of building wealth and in reality, still is today. If the economy does get hit by a wave of CMBS foreclosures, it’s not because of the land, it’s because of us.

Wednesday, September 9, 2009

Bloomberg Gives Real Estate Two Sentences

By David Sobelman

I was listening to Bloomberg radio in the car today and they started talking about macroeconomic indicators. After they got done talking about retail sales and the Cash for Clunkers program, they began to delve into real estate. The most amazing part of the conversation was the length of time they spent on the topic. I was so ready to start my mental rolodex of every real estate term I have ever learned in order to keep up with their conversation. But low and behold, I was disappointed. They essentially mentioned real estate as an indicator and that, at this point of the “recovery,” everything would be fine. Discussing the decrease in pricing for homes while the volume of sales increased was mentioned. Commercial real estate got an acknowledgement insofar as to say that it’s a small part of the real estate market and an even smaller part of the economy; so they weren’t too worried. Does that mean I shouldn’t be too worried? Does our entire industry deserve a long segment of discussion from the economists on Bloomberg or should we be as blasé about the market turning around as they were? Two sentences are all we got from them. All I can say is that while I see signs of improvement on a daily basis, I think there is a little more to the real estate market than could be said in two sentences. Stay tuned, hopefully we’ll get more hindsight, insight and foresight from our experts.

Thursday, August 20, 2009

Is Net Lease Back?

Last Thursday, Globe Street’s very own Michelle Napoli reported that Realty Income Corp, one of the larger players in the REIT market with a focus on net lease investments, has begun looking at acquisitions. Specifically, CEO Tom Lewis said:

“I know there will be some modest acquisitions in the third quarter, and I’ll define that as a trickle, and we’ll see where it goes from there.” He adds, “We are looking at transactions and buying again.”

This is highly significant information because, as Lewis states himself, “it’s been about 20 months since we put out an LOI on a property.”

The fact that Realty Income’s previously muted presence is coming to an end amongst a series of acquisitions could point to the long elusive light at the end of this recession wrought tunnel. At least, as far as the net lease market goes.

And who is the culprit for this recent spat of good news?

Why it’s those two eternal forces of capitalism, who until recently were not on speaking terms: Buyers and Sellers. The gap between them seems to be closing, especially in terms of seller expectations. Which are becoming, as Lewis notes, “more realistic.” This means that for those who have prudently stored capital, the time may be now to start buying. And in a market as tumultuous as this, net lease investments with their incumbent safety, may be the place to start investing.

Bolstering this perception is a recent upgrade by Friedman & Billings Ramsey Capital of Cap Lease Funding’s target, elevating it to $6.00 from the previous $4.00. This positive development for Cap Lease Funding, which specializes in Net Leases, could very well be indicative of the entire market. Taken together with Realty Income Corp’s new dalliances, we may be seeing the beginnings of a positive trend. So look out world, there may be sunny weather ahead.

Monday, August 10, 2009

Net Lease Solstice

By David Sobelman

When describing the point at which the Sun's apparent position in the sky to reach its northernmost or southernmost extreme, one can only wonder if that is what is happening in the net lease investment community; has there been an extreme change in the industry. We have all seen transaction volume decline, but is that the only variable driving the market? What about capitalization (CAP) rates, lease terms and values of underlying real estate. Has an extreme determination been concluded on the net lease investment market? Are we reaching the "solstice" and will we now see stabilization over time? One thing is for sure, investment parameters have changed, but an extreme polarization of the net lease market has not. CAP rates remain somewhat stable as compared to more volatile investment segments, i.e., vacant properties, land, multi-family, etc. So reaching the net lease solstice has not occurred and may not as the nature of the investment segment does not allow itself the volatility of extreme market changes.

Tuesday, July 28, 2009

Golf and Waffles?

By Bridget Lyons

Professional Golfer Phil Mickelson is taking a swing at the franchisee business. He recently made a bid to buy a Nashville based franchisee for Waffle House out of bankruptcy with his two business partners. GS Acquisitions LLC offered $20.2 million in cash and payments to the US Bankruptcy Court to bail out the ailing SouthEast Waffles, a 105-restaurant group that has locations in four states. The Waffle House parent company has a right to oppose the purchase and has declined to comment as of yet, however, they had placed an earlier bid of $19 million.

Friday, July 24, 2009

Does Greening Your Commercial Property Make Financial Sense?

By Joan Pino

The term ‘responsible property investing’ refers to the active selection and maintenance of properties that exhibit social and environmental conscientiousness. ‘Responsible’ in RPI expresses an objective of accountability as well as smart business, which translates into economic benefits directly passed on to the bottom line. Recently, commercial investors with RPI ambitions have been drawn to environmentally friendly or ‘green’ buildings on account of their clear alignment with the RPI outlook. At first glance green buildings may appear as an unnecessary increase in initial capital outlay, however; investors in green buildings have confirmed them to be sustainable ventures that maximize property value while minimizing risks associated with volatility of the market, creating an ideal investment for anyone.

Until this point in time, the ‘green cost premium’ has been a major deterrent to investors greening their properties. Over the past ten years, costs of green building materials have become more competitive with conventional materials, ultimately causing the green cost premium to disappear. According to a 2006 study conducted by the Davis Langdon firm, “many projects achieve sustainable design within their initial budget or with very small supplemental funding.” If this is holds true, the need for commercial real estate investors to financially justify opting for a green building would be eliminated.

Investors in green buildings have reported gaining several significant benefits unattainable with non-green properties. Studies have documented improvements in rental performance (rates, occupancy, and retention), risk management, and tenant relations. In addition to actively seeking green buildings, investors can make upgrades to buildings already in their portfolios through a variety of improvements which will make their properties superior investments. The costs of these upgrades can even be passed on to the tenant, the entity which stands to gain the most from the evident benefits (decreased operating costs, improved environmental air quality, increased employee productivity, etc.), through a green lease. The EPA’s ENERGY STAR® program has developed a tool called the Building Upgrade Value Calculator (BUVC) which allows building owners and/or tenants to assess the financial costs, benefits and implications of energy efficient measures specific to their building and situation. The tool provides a useful financial summary (net investment cost, pay back period, ROI, NPV, IRR, etc.) calculated from the given inputs (square footage, annual utility bill, costs and predicted annual savings of energy efficient measures, possible rebates and additional savings) to give investors an estimation of how green upgrades will affect their bottom lines. The BUVC works off the income approach of asset valuation (asset value=NOI/Cap Rate), assuming energy savings flow directly to NOI. Although the tool was originally designed for office buildings, most of its functionality is applicable to all space types (the figures that the tool generates specific to office buildings are potential impact on NOI and asset value). The BUVC is a MS excel workbook that can be accessed here. The ENERGY STAR website also has suggestions for cost-effective upgrades appropriate for different building types (retail, QSRs and casual restaurants, grocery stores, office buildings, etc.).
Investing in green buildings may have been impractical and costly in the past, however; the eradication of the green cost premium coupled with increasing risk aversion begs the question, why not go green?

Monday, July 20, 2009

Calkain in the Spotlight

Calkain Companies is highlighted during an ABC interview with James Brennan, Managing Director of Exchange Solutions Group 1031. Mr. Brennan overviews the ways a 1031 exchange can help many Americans defer their tax liability and speaks on possible future trends. Click on the video below to watch!

Wednesday, July 8, 2009

Flight to Quality Now Boarding

Posted in on July 5, 2009

By David Sobelman

I first heard the phrase “flight to quality” during my first job in commercial real estate. I was a research analyst sitting in a cubicle, staring at my computer screen and wondering why there was over 500,000 square feet of negative absorption of office space in Washington, DC--in one quarter.

The year was 2002. That was quite a rude awakening for not only me, but every landlord in our nation’s capital. What do you do with all that vacant space in such a short period? The answer: Lower your rental rate. Tenants began filling vacancies and getting better office space. It was a flight to quality.

But net lease investments are different when considering quality, which is a popular word these days. In the net lease investment industry, we’re typically not discussing the leasing of a single-tenant office building, a large warehouse or a small retail center. We’re discussing investments--the purchasing of assets for an immediate return.

So how does one define a flight to quality when considering a net lease? It depends who is buying.

People want more for their money in today’s market. However, quality varies in any investment, let alone net leases. The first quality adjustment we are seeing is a desire for choice real estate. Location is still of the utmost importance to investors.

Buying a Walgreens location in Dubuque, IA is different than buying one in New York City. You may be getting the same credit and same lease terms, but the real estate has become a big consideration for investors today.

The investor has to know that at the end of the day, they are still buying real estate. Consider the worst-case scenario: If my great tenant leaves, what am I left with? Where is the building? What is around the site? How can I access it? We are all real estate professionals, but the quality real estate was forgotten for many years.

Additionally, investors are focusing more on the credit of their tenant. Gone are the days that you can put a very aggressive cap rate on a one-unit franchise operator of a concept that you have never heard of before and close the transaction in 21 days.

The investor’s flight to quality for tenancy has become drastically more apparent in the last 12 months. In 2008, when it truly did seem that the sky had fallen and was actually beginning to dig a hole to the center of the earth, no one was really sure of how to rate a company’s credit. Those institutions that had a credit rating by a major agency, such as Standard & Poor’s or Moody’s, were being questioned because they got so many things wrong.

Companies with “A” credit or better were going bankrupt or being downgraded so fast that it was hard to keep track of them. The term “investment grade” almost became a joke. But now that the economics of the industry have calmed down and recovery is under way, the credit of a company seems to have taken on a new meaning.

History has proven that credit matters. Over the last half-decade, it was proven that if you had a net lease investment, you could get financing. Now, you truly need a credit rating of “A” or better to get above-average financing. Otherwise, you’re left with a full recourse loan with a very low loan-to-value ratio.

Credit tenants are still comparably garnering somewhat stable cap rates, but those that lack the financial reporting worthy of an overly scrutinized underwriting process are seeing their returns rise and prices lowered because of the perceived risk. The credit of the tenant has seen new meaning and the credit tenants are sought out more so now than ever before.

Lastly, the lease terms are becoming a talking point that quality seekers seem to be discussing more. The words “absolute” and “bondable” are heard more and more as investors seek new purchases. Triple net assets are trending to become, well, triple net.

The mere definition of the investment class started with the understanding that the tenant would be responsible for taxes, insurance and maintenance. Yet somehow over time, triple net became defined however you wanted to define the structure of the lease. Maybe the landlord is responsible for the roof and structure of the building, but not the daily maintenance. Or maybe the HVAC system falls on the landlord, but no other items.

Whatever the case may be, triple net became double net, single net or half a net. If there is some responsibility of a landlord, then the investor wants to be compensated for it with a higher return. So when an investor says that they want a triple net investment, they want to sit back, collect a check and never even get a phone call about the property. They want to think of the property once a year when they are filing their tax returns. The flight to quality is in the lease terms and investors are seeking out the absolute, most passive form of real estate ownership.
But a true flight to quality still depends on the individual investor. We have to realize quality can be defined a number of different ways. But net lease investments have truly seen a change in recent months, with scrutiny being placed on the attributes of an investment that haven’t been considered in years.

One may be able to take a great parcel of land but have it encumbered with an old and outdated building with a terrible credit tenant and turn it into a goldmine over time. But today’s investor has a somewhat different destination--a nonstop flight to an oasis called “quality.”

Tuesday, June 30, 2009

Favoring Franchises

Feature article by Jonathan W. Hipp


Tuesday, June 16, 2009

Is Detroit a Sleeping Real Estate Giant????

By David Sobelman

Probably not. But there seems to be some opportunity there. There was an article in the Wall Street Journal today, Page A3 by Andrew Grossman, that is headlined, "Retailers Head for the Exits in Detroit." The first three fourths of the article highlight the name brand retailers that have all exited the market in recent years. The news about "Motor City" obviously has not been favorable by any means but it should be known that the last column of the article highlights several success stories in recent years. Family Dollar is expanding, Aldi is "bullish" on Detroit and The Detroit Economic Growth Corporation (they recruit businesses to the area) is still in business.

The moral of the story; real estate is local. The 900,000 people in downtown Detroit still need services to survive. They need grocery stores, coffee shops, shoe stores, and the like. It just matters who the tenants are, where are they located and who do they ultimately serve. Those factors can be applied to Anytown, USA and, most likely, shed light on which retailers can/will survive in any market.

Wednesday, June 10, 2009

Jonathan Hipp of Calkain says $10 Million is the New Black

Jonathan Hipp, President/CEO of Calkain Companies, gives his insight on the current condition of the commercial real estate market. While general perception would have you believe transactions have come to a standstill, the reality is much different. Deals are still being done and money is still being made. Preference has simply shifted to lower cost (and lower risk) purchases. To find out more, check out the video.

Real Share’s annual Net Lease Conference on April 29th, 2009

Tuesday, June 2, 2009

Fear and Loathing (At The Global Retail Real Estate Convention) in Las Vegas?

By: Jonathan Hipp & Patrick Nutt

Comments by Jonathan Hipp: Let’s set the scene: We are at The Global Retail Real Estate Convention, hosted at the prestigious Las Vegas Convention Center. It’s a huge building, 3.2 million square feet of space, ready to receive a massive migration of retail real estate people from all over the country. The center is composed of over 2 million square feet worth of exhibition space and 144 meeting rooms (totaling 225,000 square feet) entrenched throughout the facility. It is here one of the largest conventions will take place; 50,000 thousand people will be packed in for four days to see and hear the latest from industry experts. Thousands of booths and tables will be set up, creating a maze of lights, sights, sounds and people that would send the unprepared into a daze. For four days, this place will be the central hub and nexus of retail real estate for the entire globe.

At least, that’s how it’s been for years past. Word on the proverbial street is that this year may be different. The new notion sweeping through offices and conference calls is that only half as many people will show up this year. Now, that is still 25,000 people, but in the context of the massive convention center, there’s no doubt people will notice the absence. Perhaps whole sections of the 2 million square feet of exhibition space will lie vacant; maybe the doors won’t be opened on 72 meeting rooms. What really should strike people is simply where did all the people go? If anyone is looking for a test of health for the industry this may be it. How bad has this recession really hurt people? If it’s to the point that half the attendance of this conference is gone, it will be a striking indictment.

This is not just some party in Vegas where people come to have fun. In the realm of business there may be no better opportunity than an industry convention to meet and gain new clients. Where else can you meet thousands of potential leads face to face, many of whom are actually decision makers at their respective companies? That’s why so many have traditionally made the pilgrimage; it literally pays off. One wonders what the attitude will be at this year’s convention; people there to look and not to buy? Let’s hope not. Hopefully the people there this year are at least viable players, ready and willing to conduct some business.

With all the supposed negative news, there are also some positive signs. Recent news may point to a healthier market for commercial real estate than some had previously thought. According to the new stress test, baseline losses for office, industrial and retail properties were projected to be 4%-5% with worst case scenarios between 7%-9%. Construction loans had baseline losses projected at 9%-12% with a worst case of 11%-15%. Multifamily housing fared a little better with projected baseline losses of 3.5%-6.5% and a worst case of 10%-11%. All told, worst case scenarios have banks loosing around $53 billion from commercial real estate loans, which pales in comparison to projected residential losses of $185.5 billion. From these numbers there is no doubt that commercial/retail real estate is healthier than it’s counterparts, hopefully that luck won’t change in Vegas.

Comments by Patrick Nutt: As I sat in the Houston airport on my way home from the annual Las Vegas ICSC convention I was thinking back over the entire experience, the meetings I had, the follow ups I needed to make, and how I felt about the whole experience. As I was “enjoying” my one-hour layover, I was informed that it would now be two hours. While I immediately regret having saved $100 on my flight in exchange for having a layover, I realized this might actually work out pretty well, as I now had time to have a decent dinner rather than surviving the entire day off tiny packets of peanuts and 5 oz glasses of the airlines best water. Over my dinner, I realized that this year’s ICSC convention was a very similar situation; I left home thinking I was wasting my time and returned realizing it was one of the most productive 2 days I’ve had in my professional career.

As I started the process of booking meetings weeks before my departure, I quickly realized I was in the minority, as it seemed no one was going to be attending. I had a high level of uncertainty going into it, wondering if the annual trek would be worth the time and effort, but once I arrived in Las Vegas and met some friends and colleagues, the small talk quickly turned to business and I realized that there really are some glimmers of hope. There were developers with new sites actively being approved by national retailers, brokers with recent closings, clients with specific AND realistic property needs, and even sellers with appropriately priced deals that made sense when evaluated based on their credit and real estate.

I’m not saying there wasn’t any pessimism at the conference, as clearly a walk around to see who was present, and more importantly, who was not present, served as a cold reminder of the times we are in. General Growth Properties booth sat in the middle of the convention, as the proverbial 1000lb gorilla, fresh off their bankruptcy announcement, it seemed as though their booth this year came complete with an erie reminder that in the world of real estate, there is no such thing as “too big to fail”. In contrast to GGP’s booth, the complete absence of America’s largest retail real estate owner, Simon Property Group was a constant discussion point among attendees.

All that being said, I was able to arrange meetings with top level decision makers, people that may have been either out of my reach or just simply too booked to make time in years past. Every meeting consisted of a similar tone: “The attendance is down and I couldn’t be happier”, “the people here are the one’s I want to do business with”, and even a slightly bitter “Good riddance!” were just a few of the comments I heard. I quickly realized, that the older generations of real estate professionals that I was meeting with have weathered the cycles, paid their dues during the down times in order to prosper in the good times. These veterans watched as the industry swelled like GGP’s debt over the latest boom, with everyone just trying to get a piece of the action, make a quick buck, while often not fully understanding what they are dealing with, and more times than not causing more harm than good over the course of a transaction.

If there is a lesson or overall sentiment to take away from this event, I would say that the show’s attendees were overwhelmingly resilient, realistic about the state of the industry, and are dedicated to a long career in retail real estate. While we may have to work twice as hard for half the number of transactions these days, if you are dedicated to being in this field, the knowledge you will learn, opportunity that will be presented, and relationships that are created through the tough times will carry with you over the lifetime of a career.


Though corporate sale-leasebacks came to a halt in Europe during the first quarter of this year, it appears likely that they will soon emerge as a major force. Many firms are in dire need of financing, and with the channels of credit and debt dried up; many will soon be looking to their property as a reservoir of cash. Currently, sale-lease-backs have been halted due to a lack of debt financing and a large disparity in perceived value between buyers and sellers. However, the gap in perceived value is beginning to close and buyers are becoming more willing to buy with cash now, hoping they can raise debt later.

A sale-leaseback is a real estate transaction whereby the owner of a property sells it for cash and then leases it back from the buyer on a long term lease (usually over 20 years). They are performed in order to provide beleaguered firms with a much needed inflow of cash, without disrupting their operations.

For instance, say Wynand Industries owns a building worth $300 million, which they use to manufacture widgets. In need of cash, they decide to sell it to a buyer, Roark Enterprises. After the sale, Wynand Industries signs a lease with Roark, allowing Wynand to use the building for as long as the lease period. Thus, Wynand can continue manufacturing widgets while also receiving an inflow of cash.

In today’s economy, sale-leasebacks are an increasingly viable option for companies who need cash. The most prominent example of this would be the New York Times, who in March completed a sale leaseback on its Manhattan headquarters which had only been built two years prior. In this case, investment firm W.P. Carey paid $225 million for the space the New York Times occupied in the building (around 750,000 square feet), with the New York Times subsequently signing a 15 year lease. At the end of the 15 year period they have the option to buy back the building for $250 million. For the New York Times, a sale leaseback was one of the only options available to them. They were in dire need of cash to pay back debt and with stocks and bonds at such low levels, monetizing their assets provided the only solution.

Many companies today are facing similar situations. This is because other cash raising vehicles such as the issuance of stocks and bonds are presently unfeasible. In good times stocks and bonds could be issued with the assurance of receiving the necessary cash in return. However, today the reduced price of stocks means investors would require hefty discounts on any stock issued, while bonds are currently being shied away from unless they are from the highest investment-grade issuers. For companies who need to raise cash in order to pay back debt or continue operating, this makes those options virtually impossible. If you are at the point of needing cash to pay back debts or continue operating, the discount on your stock would be large enough to nullify the benefits of issuance and no investor would think of buying your new debt. This leaves many companies looking at their property as a source of financing.

Though the sale-leaseback market is not without its problems, they are not so disruptive as to prohibit investment. There are many interested buyers and sellers; the issue is primarily one of financing. However, buyers are becoming more willing to invest cash today, for an investment which they could not normally acquire, and find debt later. There is also the risk of default. The sale leaseback is essentially a long term relationship between two companies; a default at either end would cause serious harm. However, the risk of default can be easily mitigated with proper underwriting and due diligence. Sale leasebacks provide an excellent way for companies to convert their assets into cash, but analysis of the respective parties is required to ensure a viable transaction.

Currently, the restrictive tides of today’s market have stemmed the flow of sale-leasebacks. There is a lack of buyers due to price disparity and the availability of cash or debt. These ailments run throughout the real estate market today, leaving property investment as a whole at a stand still. However, it is likely that momentum will return to the market sooner rather than later, especially within the sale leaseback realm. The demand for cash and lack of debt is forcing many companies to consider monetizing their property. With much of this property in prime location, it is reasonable to assume that eventually buyers will be found.

Tuesday, May 26, 2009

“Curses are like young chicken, they always come home to roost” And So Has the Debt of Commercial Real Estate

So you thought what we’ve seen so far is bad? New research from Deutsche Bank indicates that there is another financial crisis coming, specifically a “refinancing crisis”. It deals with the large amount of high risk, debt fueled loans which were taken out to finance commercial real estate investments between 2005 and 2007. Now with the value of these properties gravely diminished, it is projected that many people will have no choice but to default.
Starting in 2005 and peaking in 2007, underwriting standards went on a perilous “walk on the wild side”; bloating loans with so much leveraged debt that today they resemble cumbersome humpty dumpty’s teetering atop the crumbling walls of our nation’s financial institutions. A key element of debt (recently forgotten) is that at some point it needs to be repaid; in terms of loans this translates to the maturity date, when the principle on the loan is due. For a while people thought that this judgment day could simply be pushed back with the push of a few magic buttons on our financial calculators. But alas, it seems this time people will either have to pay up or get out of town (literally). However, if you fall into this unfortunate category, be comforted, for you certainly do not travel alone.
Of all the loans which are set to mature in 2009 or thereafter, 68.3% ($601.9 billion) do not qualify for refinancing. Coupled with the fact that commercial real estate prices have dropped 40-50% or more, it becomes obvious that most people will have no choice but to default either at maturity or sooner, translating to massive market upheaval.
However, hidden within all this pessimism there is still opportunity. Unlike previous commercial real estate crashes, such as that of the early 1990’s, this crash has little to do with oversupply. So though many people may default and loose their properties, the properties themselves will still have definitive value. It is better to think of this crisis as a cleansing of the system, a removal of all the risk and debt which plagued us. Concurrent with the outflow of bad money will undoubtedly be an inflow of good money and a sound ground for the future.

Thursday, May 21, 2009

Keynesian vs. Classic: Which approach do you agree with?

By: Joan Pino

As an economics major, the past year as a student has been extremely interesting to say the least. The study of the demand, production, and consumption of goods and services is always at the center of debate during a recession. Different economists, such as Ben Bernanke and Robert Barro, have been interviewed repeatedly since the start of the economic downturn by members of the media trying to make sense of the United States’ current position and what it means for the future. The two major economic schools of thought, Keynesian and Classical, are what policy makers ultimately base their decisions on to drive our complex economy.

Classical economics was pioneered by Adam Smith in his book The Wealth of Nations in 1776. He advocated the concept of the “invisible hand”, which is based on the assumptions that people pursue their own economic self-interests and that prices adjust reasonably quickly to achieve equilibrium throughout the economy. Followers of the Classical school of thought discourage government involvement and policies because of their belief that they will be ineffective in eliminating business cycles (the business cycle: boom, recession, depression, recovery). Classical economists believe that the business cycle is the economy’s natural and best response to market conditions and should be left to reach equilibrium on its own.

In 1936, 160 years after Adam Smith’s The Wealth of Nations, Keynesian economics was developed by John Maynard Keynes in response to the Great Depression and unprecedentedly high rates of unemployment. The “invisible hand” wasn’t doing its job and people wanted an explanation. Keynes satisfied the need for a new economic theory with Keynesianism, which assumes that wages and prices adjust slowly, unlike the Classical model. The slowly adjusting markets account for unemployment because wages and prices don’t adjust fast enough to keep up with the number of people firms want to employ and the number of people who want to work. Therefore, Keynes suggested government intervention with an increase of its purchases of goods and services which would then stimulate demand for output and result in companies hiring more workers to meet the new demand. Thus, Keynesians believe government policies and intervention solve the problem of unemployment faster and more efficiently than the Classical approach of letting the market clear on its own.

Today’s policy makers tend to use some combination of the Classical and Keynesian approaches, although there are certainly several economists who strongly advocate one school of thought over the other. I hope my brief explanation of economic thought and policy helps you to understand our intricate economy a little better and the reasons for things such as stimulus packages and other government policies. Do you think you are a Keynesian, Classic, or somewhere in between?

Friday, May 8, 2009

10MM is the new $100MM; A Recap of Real Share’s Net Lease Conference

Between the regular conversations with industry veterans, reading periodicals and daily press releases, and watching any local or national media, it doesn’t take much analysis to realize we are in the midst of a real estate and economic downturn never before seen. With this in mind, I knew it would be of paramount importance to attend Real Share’s annual Net Lease Conference on April 29th, 2009. This event gathered of 200 of the nations most intelligent and seasoned veterans representing all aspects of the net lease, sale lease back, and 1031 exchange markets, ranging from publicly traded REIT’s, hedge funds, private equity, lenders (yes, they still exist), as well as brokers and a handful of third party service providers. The organizers and moderators were aimed at figuring out where the market is, how we got into this malaise, and what the path to recovery should look like.

The opening remarks featured a quick synopsis of a few key statistics from a recent edition of “The Economist” which talks of the telling signs of General Growth Properties (GGP) recent Chapter 11 bankruptcy filing. As America’s second largest mall owner, GGP’s large debt load created by aggressive acquisitions during the run up of the market, namely the purchase of Rouse Company for $12.6B in 2004, as well as the recessionary environment with lower consumer spending and ailing retail tenants was it’s eventual downfall. Shorter term debt matured during an unprecedented retraction in the global financial markets. With this in mind, it was pointed out that there is $594B of additional commercial mortgages maturing in America between 2009 and 2011 alone, with no financing vehicle currently available to fill that void. While I sat pondering these comments, I mentally prepared myself to listen well and take many notes. Below is a synopsis of all the topics discussed, and what I took away from each panel, I hope it proves insightful…..

Making Sense of the Economic Downturn:

Howard Davidowitz - Chairman of Davidowitz & Associates, Inc.

  • We, as Americans, need pain, “Pain gets things fixed”
  • Living standards for Americans will never be the same as they were over the past 5 years…….EVER
  • In regards to the national stimulus plan and associated budget deficit, we are spending at an unsustainable level.
  • Interest payments on the national debt will constitute 12-14% of the GDP.
  • Retail is the worst hurt sector “All anchor tenants are in the ‘crapper’”
  • There is currently 21 square feet of retail space per every person living in the United States, while the per person demand equates to 13 square feet.
  • (Pessimistic would be an overly optimistic way describing Howard’s outlook on the economy)

Dr. Sam Chandan - President and Chief Economist with Real Estate Economics, LLC

  • America was engaged in a level of spending that was unsustainable
  • US savings rate between 2004-2006 was negative, however we are currently at 4% positive savings rate
  • While a positive savings rate ultimately is a positive movement, in the near term, it will extend the current retail downturn and weakened sales levels.“Wealth Effect” = greater spending when overall perceived wealth increases, while effective personal income does not increase
  • Currently experiencing a “Negative Wealth Effect” where income has decreased by 10%, consumer spending has been pulled back by 20%+
  • This is a different downturn than the early 90’s as there was less excessive and speculative building, limiting the supply side of the equation, however the demand contraction has been greater than previously experienced.
Town Hall meeting

  • Bruce MacDonald – President, Net Lease Capital Advisors
  • Richard Ader – Chairman, U.S. Realty Advisors
  • Peter Budko – Executive Vice-President and Chief Investment Officer, American Realty Capital
  • Gordon DuGan – President and CEO, W.P. Carey & Co.
  • Kyle Gore – Managing Director, Real Estate Net Lease Group, RBS Global Banking & Markets
  • Glen Kunofsky – Senior Director, Marcus & Millichap

Overall sentiments
  • In 2006, a similar panel discussed “what is the hot investment”, with the response of “everything”, while just 3 years later, the exact opposite is true, with no clear product type to pursue aggressively.
  • Opinions were very segregated between the Institutional investors and Private markets.
  • Recourse lending is here to stay – similar to yield maintenance which was instituted during the S&L crisis of the 1990’s.
  • Corporations will increasingly be attracted to Sale Leasebacks as an alternative to raising capital, however many corporations may have missed their opportunity, as either their corporate financials have deteriorated or the necessary capital to facilitate the transaction is simply non-existent.
  • Inflation was addressed as an issue to watch, with the current spending initiatives led by the government, it is not a matter of “if” it will be an issue, but “how bad” it will be.

Institutional investors

  • Most were out of the market for the past 3-4 years, as there was an excessive amount of capital in play, driving terms below where most saw as reasonable.
  • Only willing to pursue Credit Tenant transactions – true Investment grade tenant, signed to a lease of 15 years or greater, on an absolute net basis, with pricing based on the spreads displayed in the corporate bond market.
  • While corporate credit is key, real estate fundamentals must be present – market rents, market pricing for $/sf of building, etc.
  • Collectively mentioned that they were very inactive and overly the stressed that credit is everything in their underwriting.
  • There is a large amount of uncertainty over the implied pricing of a large transaction in today’s market, as funding a deal over $50MM requires an “act of god”

Private Market Comments

  • Investors are underwriting real estate as the primary driver in their decision making process
  • This includes an understanding of market rental rates, reasonable building and land costs, and reasonable re-tenanting for alternative use.
  • The large premium for purchasing a real estate asset that includes an income stream has been largely eroded.
  • The days of purchasing retail bank branches paying $80/sf in rent when market is $20/sf are over.
  • Private market players generally have a depository relationship with a local lender that is still providing relatively aggressive loan terms, although it is full recourse
New Realities of Debt Financing

Gerald Levin – Senior Managing Director of Sale-Leaseback Capital, Mesirow Financial
Barclay Jones – Executive Vice-President of Investments, iStar Financial
Andrew Kroll – Director, Debt Capital Markets, SunTrust Robinson Humphrey
Daniel Own Mee – Executive Director, Tremont Realty Capital
Nicholas Muzychak – Managing Director, Parkland Financial Advisors, LLC
Randy Reiff – Founder, Spartan Capital, LLC

Overall Sentiments

  • The Commercial Mortgage Backed Securities (CMBS) market may never come back, that product is inherently flawed.
  • The world as a whole is over-leveraged
  • Recourse is here to stay for the most part, you will have to pay a significant premium on an “A” product to get non-recourse.
  • Current rates vary between 5% to mid 6% for recourse money, some lenders will do non-recourse at low leverage at 7%+.
  • If CMBS market comes back, syndicating bank will have to remain in the deal, potentially structured as having to hold 20-30% of the paper
  • There is no product that currently exists to fill the void of the CMBS market, however lenders and capital sources are actively working on a solution, but it will be a slow evolution with many victims before a real product exists.

When posed the question of “In today’s market, describe a deal you would pursue”, here is what a representative from the following institutions answered:

  • Mesirow Financial – recently closed a $60MM deal for a “A” rated tenant, but we had to utilize 4 separate lenders to fund the transaction.
  • Suntrust Robinson Humphrey – True Credit Tenant Lease deal on a Sale-Leaseback or Build-to-Suit terms.
  • Spartan Capital – There isn’t a deal worth pursuing at this stage
  • Parkland Financial – Similar to Suntrust’s response – would need to be a true Credit Tenant, with 15+ year NNN lease through either a Build-to-suit or Sale-leaseback transaction.
  • iStar Financial – There are currently no real opportunities worth pursuing
  • Tremont Capital – Strong credit-tenant with strong real estate fundamentals on a basic 70% LTV transaction.
Net Lease Insider:

Paul McDowell – CEO, CapLease, Inc.

  • There is more pain to come on the real estate side of things
  • Public markets and owners have taken their hits (for the most part), but there are still private investors trying to hold on to bad assets.
  • Deal size - “$10MM is the new $100MM”
  • In regards to a lack in confidence in credit ratings as a guideline, “default of an ‘A’ rated company may occur, however it almost always requires many years of bad corporate management, and generally is coincided with downgrades along the way”
  • Real estate investors are like “wildebeests trying to cross a river filled with crocodiles. There is pressure to move forward by the herd, but everyone knows the first to act is in the most danger”
  • 2-3 years ago the outlook was “Everything is good and there is no end in sight”, however today the outlook is “Everything is bad with no end in sight”

Roundtable discussion - Net Lease Opportunities in the Medical Office Sector:

  • This sector has garnered a lot of attention, as a recession resistant product type, however the basic fundamentals of market rental rates must be present
  • Tenant creditworthiness is being overly scrutinized, as the relatively hot properties must be guaranteed by one of the top two health care organizations with the market place
  • While private physicians tend to be good at creating a large amount of cash-flow, they generally lack the ability to build significant net worth when compared to a typical tenant guarantee in other sectors.
  • There are some attractive medical office tenants that fall within the private market for single tenant assets, such as Affordable Care, Fresenius Medical, etc.
  • On-campus medical facilities will fetch 25-75 basis point premium over off-campus facilities.

Underwriting Credit & Tenant Retention Strategies:

Merrie Frankel - VP/Senior Credit Officer, Moody’s
Benjamin Butcher – CEO, STAG Capital Partners
Robert Corry – Managing Director of Real Estate, Gladstone Commercial Corporation
Peter Mavoides – President & CEO, Sovereign Investment Company
David Steinwedell – Managing Partner, AIC Ventures
Gordon Whiting – Founder & Sr. Portfolio Manager, Angelo, Gordon & Co.

  • Experiencing relatively similar actual ratios of defaults, per letter grade, as the early 1990’s recession
  • A signaling event that things are looking better would be “Tenants Paying on Time!”
  • When tenants want rent relief, they better offer up to date audited financials and be willing to have an “open book” relationship between tenant, landlord, and lender (if debt is in place)
  • The Sale Lease Back and Net Lease business should be 15+ years view.
  • Property types to pursue, if not a publicly rated entity, should only be critical assets that are part of their core business in irreplaceable locations.

All in all, after eight hours of discussion covering all aspects of the net lease business, I can truly say that the general sentiments were that of determination to survive and profit on the way out of this mess. The number one issue is DEBT. We need a lot of it, and have none available. Lower leverage is a good thing, and it will take a while to de-leverage, but near-term debt maturities will sink many owners. Most people have realized we are currently at the ID stage, where we have realized the majority of the problems, and now need to focus our efforts on finding a solution. The “blame game” for why we are here can be sorted out later, right now we need to be creative yet conservative to move forward. If you have any questions about items mentioned, or would like to discuss any of the topics in greater detail, Please feel free to contact Patrick Nutt at or 813-282-6000.