the hire-profit advantage

New Mexico Leads Nation: Largest Decrease in Unemployment Rate

2011-04-19T14:37:00.000-07:00

New Mexico’s unemployment rate fell to 8.1 percent in March, down from 8.7 percent in February, according to the U.S. Bureau of Labor Statistics.

New Mexico’s .6 percent decrease in the jobless rate in March was the largest percentage drop of the 50 states and the District of Columbia.

Unintended Consequences

2011-02-27T18:29:00.000-08:00

Several weeks ago, I read a Washington Post article on the President’s plan to overhaul the US housing market. In part, the plan will require larger down payments and higher fees for home loans. Without commenting on the merits or lack of merits on the plan, it is easy to understand the intended consequences. In the medium to long term, this plan should stabilize the banking industry’s capital base, and serve to phase out dependence of the US housing industry on Fannie Mae and Freddie Mac. To name a few, some anticipated consequences include a higher savings rate for the US consumer, a slowdown in home sales, appliance sales, and the home improvement industry. This expected drag on the economy may be largely offset by an increase in business lending due to a higher savings rate. What is more difficult to anticipate are the unintended consequences.

What are unintended consequences? For the purposes of this blog, unintended consequences are consequences, as a result of Government policy, which one would normally not anticipate, nor did the drafters of the policy intend to happen. In other words, they are unintended.

Unintended consequences can be both positive and negative.

There are those who feel the current unrest in the Middle East and North Africa is at least partially attributable to Fed’s loose monetary policy over the past three years. I am of the opinion that loose monetary policy will find a way to manifest itself as higher prices somewhere in the economy. The intended consequence was to stabilize asset prices, primarily real estate, and prevent a complete economic meltdown. Whether this happened or not is open to debate. What has happened is that commodity prices have raised. Egypt is the world’s largest importer of wheat. Wheat is priced in dollars, and the Fed has been overproducing dollars for more than two years. Consequently emerging markets throughout the world — and the food sector in particular — are suffering from rising inflation. Add to this, slow growth, high unemployment, general resentment for autocratic rule and the result is unrest in the Middle East and North Africa. For the US this poses some unpredictable consequences for energy markets and political stability in those regions. None of which were intended by the Fed’s loose monetary policy. If the long term result is more stable region with governments friendly to the US then the policy had positive unintended consequences, if things head in the other direction then the result is a negative unintended consequence.

Assuming the Administration’s plan to overhaul the housing market gets enacted, what are the unintended consequences? Frankly, I haven’t a clue, but I do enjoy the mental exercise of trying to forecast the unintended consequences. For example, we can safely predict that home sale growth is adversely affected. From this we can assume that apartment and rental rates will go up, leading to an increase in the production of rental inventory, where are the rentals built? What are the effects on US suburbs, does suburban population decrease, does urban population increase. If urban population increases, what happens to the sales of pickup trucks, small cars? If small car sales increase, do highway traffic deaths increase or decrease? From a financial, societal, cultural and economic stand point where does one place one’s bets? What do you think?

Lease Up Your Shopping Center

2011-01-31T19:45:00.000-08:00

If you are involved with commercial real estate: developer, owner, broker, banker, mortgage broker, or real estate manager, you’ve had to adjust your business since 2008. Some of you have adjusted your business voluntarily, some of you involuntarily. For me, the past 3 years have been an incredible learning tool and invaluable real life case study.

A phenomenon I’ve followed closely is the difference in strategies by landlords in leasing their shopping centers. Some landlords have filled or kept their shopping centers full, others haven’t. As a broker, I like to think the landlords that have full shopping centers are a function of my fine work. As good as it may feel to think that, I have to admit my contribution (although important) is one small factor out of many.

The factors affecting vacancies in a shopping center include: the property itself, understanding the centers pro-forma, local market conditions (neighborhood), local market deal points, landlord’s financial condition, the macro economy, and a leasing plan.

So what separates a full shopping center from a shopping center with high vacancies?

Landlords with full centers know their properties and are honest about the type of property they have. They understand the location of the property, the neighborhood, and the condition of their property. Based on the above they know the type of tenant that fits well in their center. For example, national credit tenants rarely go in aged centers with low income demographics. Conversely, local credit tenants don’t match well with new, class A retail centers. If a property is in low income demographic and your space is 3^rd generation or older, chances are you won’t attract many national credit tenants.

Knowing your pro-forma is critical. Understand your investment goals and be prepared to adjust your investment goals based on local market conditions and the macro-economy, either up or down. Keeping the bank happy is important, however, passing up a good tenant because you are unwilling to reduce your return, and leaving a space empty for a lengthy period may hurt your investment. If you choose to forego the tenant, make sure you know exactly the trade off in dollars per square foot of empty space per month of empty space. For example, forgoing on a tenant because you are $1.50 per year apart on base rents may make sense if you are comfortable you will soon lease the space for more to another tenant. However, if vacancy rates are high and the macro economy is unfavorable, leaving that space empty for an extended period may have a more negative impact than accepting a lower rent. From experience, successful landlords will put the tenant in the center and negotiate a lease that incorporates the rent deficiency over time.

Another important factor when leasing a shopping center is knowing the neighborhood and sub-market. Understand the service deficiencies for your center’s trade area. Get your broker to perform a gap analysis. Find out what the neighborhood needs in terms of retail services. Then take it one step further, find out the dollar size of the market for each of those deficiencies for your center’s trade area. This allows you to set a priority list of uses, and identify tenant targets. Know the vacancy rates for your center’s trade area. What is your competition? How are you priced against your competition? A good broker knows to gather this information and has the tools available to gather this information. A word of caution, regardless of how accurate the analysis, properties don’t get leased if the landlord is not honest about their property. Pride in ownership is admirable; allowing that pride to negatively impact the value of your investment is bad.

Focusing on competition; any center in your trade area with empty space is competition. Know the leasing market in your trade area. As stated, know what rents your competition is charging? Are you in the same range? What tenant improvements are being offered by your competition? Are your tenant improvements comparable? What concessions are being offered by your competition? Are your concessions comparable? Multiple studies have showed that as human beings we overestimate our abilities. For example, many center owners assume they are smarter and more competent than competing center owners; therefore they will lease their center when their competition can’t. This may be true, however, leasing is primarily a function of external factors. Pay attention to the external factors and lease your center.

The next factor that affects the vacancies in your center is your financial condition. Center owners need to have thick skin and high self-esteem. If landlords are going to succeed they need to be brutally honest with themselves about their financial condition. This is real estate, there are good times and bad times. There are cash rich times and cash poor times. If you are at the top of the cycle you can afford to offer concessions that attract tenants. Everything is easier when you have cash. If you are in a down cycle, you can still successfully lease your center, but you need to understand and take your cash position into account. I’m not advocating giving up the farm in free rent. I am recommending you take the time to know your respective tenant, understand their goals make sure they understand your goals, and find a way to meet as much of your respective goals as possible given the limitations.

Do you understand the macro economy? I mean really understand the macro economy? This means more than being able to say “man this is a tough economy.” Most of us watch the news and know the national and local unemployment rate, but what industries are doing better than others? Of those doing well, which are deficient in your center’s trade area? What’s the absorption rate in your market, in your trade area? How much new, competing inventory was introduced to your market and trade area last quarter? What is inflation this year, what is expected inflation next year, in 5 years, in 10 years? Do your annual increases reflect expected inflation rates, or do you charge 3% annual increases regardless of expected future macroeconomic conditions? Understanding the big picture helps you structure your leases so you keep your tenants. A contributing factor to the many vacancies in the current market is a reflection of inflated rents during the bubble.

Finally, develop a leasing plan. Review the main points; know your property, know your trade area, know your competition, know your financial condition, and understand the big picture. Do your homework. Stay objective and try not to overestimate your abilities or centers attractiveness to tenants. Plan for long term success and you’ll have a much better chance of keeping your center leased.

The Power of the Infrequent Event - Originally Published 10/2009

2011-01-30T21:14:00.000-08:00

As I've stated before, I am wary of economic and financial forecasters. Mainly because they are seldom right, and when they are wrong the social impact is significant. There exists a fallacy in economic and financial forecasting models that most tend to ignore. The fallacy exists because forecasting models rely on assumptions that fall within a predictable realm. The calculation of risk in financial and economic models are based on standard deviations from the norm, therefore most models predict that 95% of possible outcomes will fall within 3 standard deviations. The farther an event falls from the norm, the less statistical significance that event carries. Another term for standard deviation is sigma. In finance, a six sigma event is characterized by a price drop of six times the volatility (or standard deviations) of the asset. On a daily horizon this translates into an event occurring once every 2,500,000 million days, or every 6,849 years. Yet in the past 22 years financial markets have suffered the following six sigma events: the '87 market crash, the Russian devaluation, the Asian crisis, the bursting of the Internet bubble, and the current 2009 recession.

Since my first day in Econ 101, I've been struck by the absurdity of academic rigor. On that day my professor managed to take an intuitive concept and confuse it. Of course if more people demand my product I can charge more, and guess what? If I'm the only one making my product and a lot of people want it, I can charge whatever I want for that product! That led to discussions of elasticity and more classes to include economic modeling. Even then, I was wary, how could any econometric model take every possible variable and interaction into account? The answer is they can't. That's why we've had multiple six sigma events (events that statistically should occur only once every 6,849 years) in the past 22 years. The problem with these models is that they can't predict that terrorists will fly planes into the world trade center, or an outbreak of the flu may cripple consumer spending in the domestic US market, or that some inventor will develop a battery that can safely store energy with 99% efficiency. Heck, they can't even predict events they should, like the over valuation of US residential real estate market, or that someone that makes $40,000.00 per year can't repay a $400,000.00 mortgage.

The point here is that infrequent events shape our history and our future. It is not the predictable that we should concern ourselves with; It is the unpredictable. In investing, the return on placing a winning bet on the infrequent event is far greater than placing a winning bet on the predictable event, especially when placing that bet on the predictable event is negatively impacted by an infrequent event. To do this you must expose yourself the infrequent events and place your bets. Look for that inventor that is developing the battery that stores energy with 99% efficiency. Look for that company that is converting 18 wheelers from diesel to natural gas. Look for the next breakout technology, tablet computing across 4G? What's the next break-out application? Where does social media take us? There are opportunities to bet on infrequent events, whether you bet on business, politics, or social issues. You just need some creativity.

2010/2011 Real Estate Strategies - Originally Published 12/2009

2011-01-30T21:10:00.000-08:00

I have spent the last 18 months making a living disposing of distressed properties for my clients. From what I can see, I'll be busy for the next 12 to 18 months. However, its time to change the business plan. The reason, every broker I know is becoming a disposition broker. When too many people start chasing the same cheese, its time to chase different cheese.

So where is the new cheese? I've been selling it for over a year now: distressed real estate. 2010 is the year to start buying distressed real estate. There are several reasons for the change in strategy. For the past 2 years, investors have been waiting for the bottom to fall out. It didn't. The market for commercial real estate consistently deteriorated throughout this period, but never capitulated. The commercial real estate market will continue to deteriorate through 2010, and bottom in 2010/2011.

Why will commercial real estate bottom in 2010/2011? First, the residential real estate market is nearing the end of its depreciation cycle. Once residential real estate begins to appreciate, the capital base will stabilize. Normally, this would lead to increased bank lending, and may do so this cycle also. What is unknown is the extent of toxic assets that the banks are still carrying, so lending will increase excruciatingly slow. Cash and liquidity will continue to rule through 2010 and into 2011.

Another important factor is that long term economic cycles follow demographic patterns. The baby boomer birth rate peaked in 1961. Statistically, 46 is the age at which the American Consumer spends the most money. That means the spend curve peaked in 2007, about the time the economy started its downward trend. This cycle was exacerbated by deregulation and greed, but would have happened anyway. Perhaps less drastically, but inevitable.

The domestic US Birth Rate steadily decreased from 1961 to 1975 and then increased from 1976 to 1992 (children of the baby boomers, echo boomers). Again, statistically, the peak spending years for the American Consumer are from the age of 35 to the age of 46, the children raising years. Consumers born in 1976 turn 35 in 2011 and will peak in spending in 2022. The birth rate increased from 1976 to 1992, so the US economy will experience increased spending and consumption through 2038, with the bubble occurring from 2022 to 2038.

The banking industry hasn't done any significant lending since 2008, and shadow banking has disappeared. As stated, this trend will probably continue into 2011. This means little to nothing has gone vertical in two years and won't start for another two years. Once the capital base has stabilized and the banks start lending again, asset values will increase. This coupled with previously discussed growth in consumption will spur commercial real estate development. Demand for commercially develop able land will increase rapidly.

Commercial land is currently the most depreciated of all asset classes. This is a classic buy low, sell high scenario. There are several caveats. By necessity, land purchases are cash purchases. Distinguish between good and bad markets. There are parts of the US that will experience more growth than others. The Southeast, the Southwest, the Rocky Mountains, and the Pacific Northwest can expect to see the most growth over the next bull economy.

Plan the next 25 years. Be prepared to hold for a minimum of three years. Plan exit strategies over time: selling unimproved land, selling improved land, develop and sell, and develop and hold. All these exits have different time frames and should be planned over the next 25 years to maximize exit value.

In short my buzzwords for 2010 and 2011 are syndication and acquisition. With an exit strategy planned prior to each acquisition.