Real Estate Investments and Finance

Student Housing

2010-05-12T22:53:00.005-04:00

Check out our comments in the March-April edition of the Commercial and Investment Real Estate magazine.

Student Housing Makes the Grade

CCIMs seeking a multifamily niche with plenty of demand from both investors and renters need look no further than student housing. Cap rates for student housing increased 50 basis points in 2009, while the average price rose 5 percent. Both measures outperformed those for traditional apartments, according to Marcus & Millichap’s 2010 national multifamily report.

Consider the University of South Carolina campus in Columbia, S.C., where private developers have added more than 1,900 student-housing units since 2007. Despite the increase in product, occupancy remains around 97 percent, says appraiser Michael Dodds, CCIM, managing director at Integra Realty Resources in Columbia. “The university works well with developers and actively refers potential tenants to the off-campus developments.”

In 2008 alone, four complexes totaling more than 800 units sold at prices ranging from $97,000 to $152,000 per unit in Columbia. Projects include both new construction and renovations, such as Philadelphia Management’s conversion of the historic Olympia and Granby Mills into student complexes with four-bedroom units as large as 2,800 sf.

Student housing often reflects class A finishes and amenities, a characteristic that tends to place those assets out of many private investors’ price range, says LyLy Fisher, CCIM, owner of Fisher & Co. Real Estate in Austin, Texas. Prices of $30 million to $40 million for a single complex are common. Still, Fisher finds it easier to line up investors for student housing than for conventional multifamily deals. “I have a waiting list of investors who are ready, willing, and able to pursue student-housing projects,” she says.

Local banks that understand the university and market are a good source of leverage for campus-oriented multifamily projects, according to Ken Etterman, CCIM, managing principal at Redfish Advisors in Asheville, N.C. Etterman’s company recently obtained construction loans on three separate student-housing projects for a total of $45 million in financing.

Rental demand and cash flow are seldom problems in this niche, so the deciding factor on qualifying for most loans in the sector is equity. Etterman says borrowers should be prepared to plunk down 20 percent to 30 percent (actually I expressed that it would be 25 to 35% LTC and I don't agree that rental demand and cash flow are seldom problems in this niche they definitely may be problems) of the project price in cash.

Investors need educating before attempting student-housing projects. Renters today expect one bathroom per bedroom, with two-bedroom, two-bath and three-bedroom, three-bath units preferred, Etterman says. The difficulty of adding bathrooms to older, four-two units make rehabbing many properties impractical, so a rehabilitation may require teardown and replacement.

Property management also is a key to a success, experts say. “These projects are not successful if they are managed as traditional multifamily properties,” Etterman says. “They require a higher level of management and oversight, so it’s probably wise to involve a third-party manager with a focus on student housing.”

Waiting with Confidence

2010-04-01T07:52:00.003-04:00

From the why we do what we do series…

John 11 (4-6)
But when Jesus heard about it he said, “Lazarus’s sickness will not end in death. No, it happened for the glory of God so that the Son of God will receive glory from this.” 5 So although Jesus loved Martha, Mary, and Lazarus, 6 he stayed where he was for the next two days. 7 Finally, he said to his disciples, “Let’s go back to Judea.”

Patience is a virtue only if you have a reason to believe that your patience will result in something hoped for. Those who place their trust in Jesus Christ can have confidence in knowing that God loves us, He is on the move and he will not leave us alone--though for His purposes he may have us wait on him. Waiting can be difficult and unnerving but it builds our faith and strengths our resolve. Wait, in confidence.

The Best Intentions

2010-03-02T20:47:00.001-05:00

A recent story in the WSJ highlights how the rules have changed. The article details how a group of tenant-in-common (TIC) investors who had purchased an office building in Memphis, Tennessee for $21 million lost all of their equity investment of $7 million. The problem occurred when the loan (which had been placed on a non-recourse basis with Key Corp who latter securitized the loan but held the servicing rights) matured and the management company of the TIC was unable to identify a replacement lender. The servicer's response to the matured note was to foreclose despite the fact that the cash flow from the building continued to service the debt (though the primary tenant had vacated they continued to pay rent). The investors had bought into what at the time would have been considered a conservatively leveraged transaction at 67% LTV. However, today this conservative structure did not help them because despite a 33% equity position (which would have eroded with the market) the illiquidity in the market resulted in a total loss of the investment. Leverage is a double edged sword and engineering of the capital stack may not be as wise as once thought especially for small investors who have limited knowledge of real estate investing and the risks inherent when leverage is added to the equation.

Understanding the Risk

2010-02-07T14:02:00.001-05:00

We recently have had the opportunity to work with investors in their due diligence of proposed real estate investment funds. Investing in a private equity or debt transaction requires an enhanced level of due diligence. Not only must the underlying real estate investment be thoroughly vetted but the ability of the sponsors and their business plan must be considered well. Assessing the risk in a transaction is critical prior to investing. Many of these business plans are non specific, for example, they propose in investing in distressed assets without much specificity with regard to product type, geography, leverage, use of funds, and other considerations. Fund organizers prefer to provide themselves with as much latitude as possible but with this latitude comes a higher degree of risk for the investor. We prefer funds that are very specific in their approach and limit their use of leverage, this of course will generally result in a lower return (lower risk-lower return). When analyzing investments such as these the assumptions of the organizers are of critical importance and the promise of a higher return always entails higher risk (always).

Glass-Steagall Redux

2010-01-22T00:22:00.001-05:00

The proposed return of Glass-Steagall like restrictions on commercial banks was reportedly the cause of the market's decline on Thursday (WSJ article). The Obama administration says that it is not its intent to restore Glass-Steagall but its proposals come pretty close. As a student of banking and finance I don't think this is a bad idea. The repeal of Glass-Steagall was probably one of the leading causes of the financial meltdown as it removed Depression era firewalls that would have stopped or at least severely limited the collapse of the financial dominoes. The removal of the G-S restrictions also added fuel to the fire by creating an overheated and ultra-competitive financial environment where the speed increased at the turn of every lap (ultimately leading to the largest pile up of financial firms the world has ever seen). By allowing commercial banks to enter the world of propriety trading and risk taking the repeal of G-S put the equity of all of the nation's large banks at risk. Big profits are available in trading the firm's capital, so are big losses. If you don't believe me ask anyone at Bear Stearns or Lehman.

We 1031

2010-01-21T23:30:00.001-05:00

I was asked if we work with 1031 exchange buyers. Yes. Yes, we work with 1031 exchange buyers and because we are not encumbered with listings we can focus on identifying and closing within compressed timeframes. Bring it on.

Negative Waves

2010-01-18T10:31:00.012-05:00

Enough with the negative waves—have a little faith. This is the truth, we can't change the world, only our reaction to it. Not that the point is to ignore the realities of the current marketplace but to accept them and work hard to find opportunities and solve problems. Dig how beautiful it is out here, say something righteous and hopeful for a change.

Bobby, say it ain’t so…

2010-01-05T17:12:00.005-05:00

Am I passionate about real estate? Eh, dirt is dirt. What I am passionate about is helping people succeed; it just so happens that my skill set is in real estate and real estate finance. I am a proud graduate of Florida State University and it was with mixed emotions that I watched the Gator Bowl on January 1^st. It was the last game that one of my heroes, Bobby Bowden, will coach. It was a great game and a great win for FSU and Bobby. What was distressing was Bobby's post game meeting in which he told a bunch of reporters that he made some bad investments in real estate. Apparently he and Ann invested in land that isn't selling "worth a crap" (Bianchi-Orlando Sentinel article). Bobby, it didn't have to be this way! This is what I am passionate about; working with our investor clients to analyze an investment opportunity, identify the risks, and where possible mitigate those risks. Eyes wide open! Land is one of the riskiest investments and in my view not suitable for investment dollars that are outside of a gambling portfolio. Help me, help you. That's what I do and that's what we do at Redfish Advisors.

Don't pay a premium for an uncooked steak.

2009-12-09T22:11:00.000-05:00

Let me ask a question. Would you pay more for a corvette that was ready to drive or one that you had to assemble? How about a dinner that you had to prepare or one that was already prepared? Simple right? You’d pay more for the assembled corvette and the prepared dinner. This principal applies in real estate investing as well though we regularly encounter sellers who believe that the buyer should pay for the value that they (the buyer) will add. For example, the buyer bringing in a tenant or selling out unsold condominium units. The value to be created should not be paid to the seller, period. We recently looked at an office building that was for sale. The building was (and is) vacant. One hundred percent vacant! The asking price is equal to the value as leased (and leased at market rents from two years ago and capped at rates from two years ago). Now, we’ll make an offer on the building but we will have to explain that their assumption of the lease rate is too high, their cap rate is too low, AND the building is vacant. Any value based on income is only any assumption since the current income is zero and the building currently throws off negative cash flow after expenses. The real value will need to be added by the buyer who will take the time, energy, and expense to find and put a tenant in place. Then the buyer could sell the building to an investor who is more risk adverse (and would not have purchased a vacant building) at the market cap rate for a leased building. It would seem that this is common sense but I am growing weary of explaining and arguing this to sellers but nevertheless we will continue to explain and fight on behalf of our investors…just takes patience.

Is the time right?

2009-12-02T21:18:00.002-05:00

Is it a good time to invest in real estate? Good question. Is it a good time to invest in equities? How about in GE, Wells Fargo, the S&P 500? I don’t like pat answers to these questions and I don’t like seeing, for example, a real estate broker in Florida telling me it’s a great time to buy a home in Florida or a broker in the mountains telling me what a value residential lots in the mountains have become. If I could answer these questions with certainty then I’d probably be in Florida fishing. The truth is we don’t know, timing the market, any market, is nearly impossible. It’s really simple, when you need to invest you need to invest and there are many options each with its own risk profile. Is now a horrible time to invest in real estate? For some real estate asset classes it is a bad time yet for other property types it’s a fine time to invest. If, if you are able to achieve the desired risk and return objectives, which are unique to each investor. This takes careful analysis and consideration.

We recently looked at a failed townhome development. The project is in a dicey neighborhood. One-third of the units are complete, one-third are partially completed, and one-third have not been started. Is it a good time to acquire this asset? For the passive investor I would say definitely not. For the developer-investor who can deliver the balance of the units cost effectively and if he can buy the busted development at the right price then it may be an excellent time. The key lies in the risk-return relationship. The cost must be right in order to price the units at a level that they can be readily sold into a distressed market. Our current economic environment is no different than the boom environment we experienced in 2004, 2005, and 2006. Was it a good time to invest in real estate then? Most thought it was an excellent time. My point is this, whether its boom or bust if you have funds that need to be invested, invest them but spend the time to understand and analyze the risk-return relationship and work hard to mitigate the risk.

Curb The Enthusiasm

2009-12-01T23:01:00.002-05:00

Enthusiasm. It’s a wonderful thing until it’s gone. It seems to be a rare commodity in our world these days. We are firm believers in the importance of enthusiasm but it must be tempered not unbridled. We have a coffee shop and deli nearby that closed in October. We weren’t surprised, they just didn’t get it. We often talked about what we would do to make the place more successful. These conversations typically occurred after experiencing a less than tasty sandwich, or the failure of a cheap coffee cup, or after getting a curt reply from the owner who was less than customer centric. When we heard of the closing our enthusiasm peaked as we brainstormed how to repackage and reposition the shop. Then we remembered, we don’t know anything about operating a deli or coffee house. So we call a friend who happens to be a very successful serial restaurantuer. Who knows where this will lead but the important point is to temper enthusiasm with knowledge and unbiased advice. This is what we do for our investors and developers. Had our industry tempered its enthusiasm a little more over the last 10 years maybe we wouldn’t be feeling the pain we are today, maybe.

The New World Order

2009-03-15T21:31:00.002-04:00

So I met someone recently who says they have a line on funding from non-traditional sources, these sources apparently are not especially interested in being repaid. In a world turned upside down the allure of a new way of doing things is very attractive. Unfortunately I remain hopelessly traditional, believing that people who have money and want to deploy it want it to come back to them at some point in the future preferably with a return attached. But, hey I am intrigued by the concept of a new form of equity and debt, especially in a form that doesn't need to be repaid--it would make the underwriting a lot easier.

The Lost Bankers

2009-02-26T00:00:00.002-05:00

These are tough days to be a banker, I talk with a lot of them and in general they are a glummy bunch. Having spent 15+ years as a commercial real estate banker I can tell you that the fun in banking is doing deals...their not doing many deals right now. While I would agree that as an industry we got a little strung out on the risk curve the current stance seems to be a bit of an overreaction. While it is true that much of the overreaction is driven by concentration issues, capital, and other portfolio points there is a significant dose of fear--fear of making a decision (right or wrong). And really who knows any more, maybe commercial real estate will implode this year and there will cease to be retail stores, no one will live in apartments, no one will stay in hotels, and people will stop going to work in offices. Its a crazy unpredictable world.

Get Going

2009-02-24T00:08:00.002-05:00

We remain active in this market, looking for new opportunities, seeking and finding placement sources, advising buyers, and guiding developers. We believe you can crawl under the table and hide or get out and get to it. Keep the faith.

Unprecedented

2008-09-18T08:37:00.003-04:00

Unprecedented. Watching the financial markets is watching history in action, I told my sons that they will study this point in time when they are in college ten years from now. It is good to hear politician’s like McCain encourage the people, we all need it, the fundamentals of the U.S. economy are strong. No, this isn’t referring to actual fundamentals such as housing prices, employment trends, and GDP growth, it is referring to the “get it done”, “go for the gold”, “where’s the opportunity” mentality of the American worker and businessman. This crisis will get worse before it gets better, we are experiencing an unprecedented deleveraging of the economy and the bottom line truth in the process is there are losses that need to be taken, wealth lost. As the smoke clears in 2009-2010 what will the financial landscape look like? I would suppose that it will look a lot like a forest after a raging fire storm. There will be few trees standing, those that are will have been the strongest with the firmest root systems, roots that spread out far and wide. Those anchored by few roots (less diversification/significant risk concentrations) or that were rooted in shallow soil (built on leverage) will be no longer. Credit will be tighter and harder to get, renting will become more accepted because while a individual might have the cash flow to service debt they will also need cash for a down payment, think 20% down payment as standard. Operating companies, real estate developers, and others will need real equity, and lots of it, to fund new ventures. An economy built on a firmer foundation but one, as least for a while, that will grow at a slower pace.

Liquidity...going going gone

2008-07-01T09:30:00.006-04:00

Over the last 10-15 years commercial real estate has moved from a predominately local/private to an international/market enterprise due almost exclusively to the maturing capital markets for real estate backed paper, specifically CMBS. Likewise residential real estate also changed from a local to an international business because of RMBS. The subprime meltdown has caused significant, but not irreparable, harm to the industry. The result of this crisis will be a decline in real estate values, not just residential, but commercial. It seems to me this issue goes back to the fundamentals that we learn in economics of supply and demand. Inherent in the supply and demand model is the assumption of liquidity, an agreeable currency to facilitate the trade. That currency in real estate is bonds. Investors in CMBS have left the house which has disrupted trade between buyers and sellers of CRE (just as it has hammered buyers and sellers of residential real estate). Cheap, easy credit made the world go-a-round, it drove up values, which drove up returns, which brought more buyers to the dance, which in turn drove up values. Now the credit is gone, the music has stopped, and many have gone home. The potential recession aside the underlying supply and demand fundamentals for CRE have not changed significantly over the last two years the difference this time around is that liquidity drives the market and with $200 billion of the table in 2008 (the ballpark reduction in CMBS issuances from 2007) it impacts all participants.

What I see from my vantage point are developers for whom the world has changed, users (e.g. drug stores) who continue to price deals like they did in 2006, traditional lenders who have taken a couple of big steps backward, and a non-functioning CMBS arena. Where is this going? I suspect that the CMBS market will return, those with a vested interest say it has to, but probably in a different format and running on lower horsepower. Deleveraging continues, developers will get used to this though the pain is significant now. Gap players will become more important, mezz, hard money, bridge, private equity sources will all have a place at the table where prior to the crash 75% to 85% senior positions were common, sometimes even higher if there was a value play (and lenders bought into pro forma numbers). It will take more creativity and work to build the capital stack for even the typical deal. Developers will probably start to use more early stage funding as commercial banks will be less willing to go too far out on the risk curve. With more players in the capital stack the cost of capital will increase which will force up costs for new projects and create an inflationary environment in CRE over the longer term. For the short term, higher capital costs mean that investors will have to pay less to generate the returns the same returns.

Consider a Walgreens purchased in 2006 for a 6.00% cap with $375,000 NOI, the purchase price would have been $6,250,000. The ROE (EBTDA/Equity) on this asset with an 80% LTV at a 5.79% interest rate is 6.84%. Today the same asset would be valued at $5,393,355 with a 70% LTV and a 7.00% interest rate to generate the same 6.84% ROE.

This is to say, that for the same asset between 2006 and 2008 the value has declined $856,645, a 95 BPS increase in the cap rate. Why, higher interest rates and lower leverage require a lower asset value to generate the SAME return on equity. Are market participants willing to take a lower ROE than they were in 2006? Probably not as the risk in the market has increased significantly, arguably they would demand a higher ROE which would push prices down further. Buckle your seatbelt, it will be a bumpy ride…

The Joys of Development

2008-05-26T08:57:00.001-04:00

Real estate development is one of the most challenging entrepreneurial endeavors I can imagine and certainly that I have experienced. The idea of spending bombastic amounts of money with no assurance of a return is unnerving, though of course with real estate you always have the land so maybe it’s not as bad as some nebulous start up. Though, every new project is a start up, even if you’re replicating a proven model. On paper things always work, or can be made to work, but the devil is in the details. Also, most everyone on the “team” is not taking risk more than their next invoice so you’re alone, really. Having worked with large development companies with deep pockets this on the edge feeling is less evident but still real, after all money is money and losing it doesn’t feel good no matter who you are. However, bootstrapping real estate development is really hard. All the stars have to align: costs, demand, design, capitalization, and timing. If one of these items is out of whack you get your head handed to you, less the design fees. That said, not having the right team who can help you design, plan, and finance your project is a greater risk and can lead to greater loss of money and time, I know I have lived this…more to come.

Beware of the control period...

2008-05-23T09:21:00.002-04:00

On the interesting news front the WSJ had an article today about the Portofino condo project in Tampa where the developer (Providence Management Corp. based in Chicago) plans to terminate the condo association and convert the project back into a rental community forcing, as provided in the termination language, owners who don’t want to sell to have to sell at the fair market value of their unit, a price today which is less than their original purchase price. Talk about being rolled (by the way the developer only owns 30 units in the 396
unit complex but must still be in his control period as he controls 92% of the association votes).

(http://online.wsj.com/article/SB121132415516908607-email.html note this link will die after 7 days)

The Condo Market

2008-05-23T08:45:00.003-04:00

In economic bubbles signs that a collapse is coming can generally be identified well before the music stops. For me I was at a golf tournament in North Carolina when I overheard two very elderly ladies discussing their strategies for securing multiple condo units in a pre sale auction process. Two ladies, two different projects and apparently they had bought previously in other projects. Now this is not a sexist or ageist comment but on appearances their speculative activities did seem to be out of the norm. Similarly during the tech bubble the WSJ had regular articles discussing what stock the barber was buying and who didn’t have a friend that gave up his day job to take up day trading…We are now dealing with the aftermath of the speculative bubble in real estate. When I was underwriting condo financing in Florida in the nineties we insured that:

1. 100-120% of the loan amount was covered by pre sales and…

2. We limited the speculative investors in the project by limiting multiple purchases to a single buyer and restricting investor units (as opposed to primary or secondary home buyers).
These disciplines fell away in the heat of the market after 2001 but are sure to return as the market heals. Sometimes these types of restrictions are good not only for the lender but also serve to place a governor on an overly ambitious developer which benefits both parties when the “buyers” disappear.

The time may soon be at hand...

2008-05-22T09:50:00.003-04:00

It's a tough time to be in real estate. Financing is difficult to secure with a CMBS market that has locked up, cherry picking life companies, and increasingly risk adverse commercial banks as a result of increased regulatory scrutiny. The drone of the mainstream press is continually negative. What to do? It may soon be a great time to be investing in real estate. Prices have moderated with increasing cap rates, many industry participants expect to see price declines of 5 to 10% in 2008. So far it appears that sellers are holding the line and this has caused a marked slowdown in sales activity, but at some point soon the new realities may make sellers more willing to negotiate then they have been in many years. We all know one should buy low and sell high but investor psyche often dictates the opposite, they buy high and end up selling low in a panic or being forced due to deal economics. For those with access to capital (and despite the increased challenge securing financing it is still available), now may be the time to be hunting deals.

As way of background...

2008-05-22T08:37:00.000-04:00

After spending 17 years in real estate finance with Wachovia Bank and Bank of America I decided to launch my own firm with the goal of helping real estate investors and developers make their efforts more profitable. Over my years in banking I saw many investors and developers who had amazing vision and drive but who failed to fully count the cost, that is, identify, underwrite, and manage the risks inherent in their investments.