On the other hand, we read stories of corporations borrowing cheap and storing up warehouses of cash for a rainy day fund, future investment opportunities, or to buy back company stock. Additionally, vultures are known for accumulating cash and then pouncing in weak markets to buy undervalued assets; they often wait a full market cycle.

Fully invested or cash on hand?

It depends: on personality (attitude towards risk), goals, and opportunities.

For me, cash is king. I want the rainy day fund, dry powder for a future opportunity, and financial flexibility. Am I missing out on today’s adventure or planning well for the future? What do you think?

Contributed by: Jim McCartney
Managing Director
Net Lease Capital Advisors
jmccartney@netleasecapital.com

Think net present value (NPV) – the time value of money. If I make a $10,000 payment today what is the NPV of that payment? It is $10,000. But, if I can pay it in ten years and I can earn on average 8% over those ten years then the NPV is $4632. In other words I save the difference ($5368) by simply deferring the payment obligation for ten years.

Yet, it may cost me something to get the deferral. Theoretically, I should be willing to pay as much as $5000 today to defer the payment obligation for ten years; but that seems like a large number. Would I be willing to pay $1500? Of course! I just changed a $10,000 expense to $6132 ($4632 + $1500).

In sum, I saved $3868 by paying $1500 to defer the payment of $10,000 for ten years. Who wouldn’t do that?

Contributed by: Jim McCartney
Managing Director
Net Lease Capital Advisors
jmccartney@netleasecapital.com

This seems to be the idea of “funds”.  Giving investors a return of 5% seems a pittance compared to what is achievable in the real estate market if you find the “right” deal.  However, it is far more than that same investor is able to achieve on his own with “traditional” investments in this low interest rate/return environment.

My recent investments have returned to me far more than 5% annually.  Although my money has not been invested for the long term, the strong returns in the short run have achieved a more than reasonable return over the last two or three years.  These returns which are in excess of a 50% IRR because of their strong return in the short term give me a more than reasonable return over a longer horizon, even if my money sits in the local bank for more than half of the time.  A 50% return in one year calculates out to a 10% return over 5 years even if the money does nothing for 4 years.  It seems, some of those fund investors should look for opportunities to make higher returns in the shorter term while still being able to benefit with higher mid-term returns.

Contributed by: Carl Christensen
Managing Director
Net Lease Capital Advisors

cchristensen@netleasecapital.com

Consumption drives today’s economy, but savings drives tomorrow’s. To save more means I have to consume less. How do I stay motivated to forgo consumption today and save when it is difficult to earn any kind of a real return in today’s market? Think long term.

Economic and market cycles are inevitable. Interest rates go up and interest rates go down; repeat. Stock prices go up and stock prices go down; repeat. Commodity prices go up and commodity prices go down; repeat. Housing prices go up and housing prices go down; repeat. Over the long haul, equity prices will trend up and interest rates will continue to roll up and down. Think long term.

And when you think long term you will earn more: money, respect, and interest from others in what you are doing.

Contributed by: Jim McCartney
Managing Director
Net Lease Capital Advisors
jmccartney@netleasecapital.com

My biggest investing mistake was failing to participate in a technology company IPO in the year 1999.

My view of the market was that technology stocks were overvalued and the bubble was going to pop at any time. In retrospect, I was right. There was a bubble that popped – two years later. And everyone else that participated in the IPO still talks about how they earned 50 times their investment. Those who held it for two years eventually lost most of that gain, but others who sold or hedged still go on about how good they were at investing. In retrospect, I was right about the market, but I was wrong about that investment. I was so smart that I did not make any money.

We always seem to be wrestling with this issue in one asset class or another. Technology stocks. Residential real estate. United States Treasury bonds. Some very smart investors saw a bubble in the U.S. government debt markets two years ago – and have lost money since. Ten years from now, looking back, they will probably be right – and wrong. Right about market fundamentals. But wrong about timing.

We seem to have the same dilemma in commercial real estate pricing today. REITs raised big money, and while deploying it, have pushed cap rates down almost as low as they were in the 2005-2006 bubble. Do these prices make sense? I don’t know. I’m too smart.

Contributed by: Jim McCartney
Managing Director
Net Lease Capital Advisors
jmccartney@netleasecapital.com

Hinging, in part, on Greek economic reform, the European economy, and perhaps the European Union, itself, could implode with significant consequences for the U.S..  Europe is the biggest trading partner for the U.S..  If Europe’s economic union fails, U.S. exports and manufacturing suffer, and U.S. banks – many of which are still struggling to stabilize their own balance sheets after being the primary recipients of American bailout funds, take another major blow.

Greece – The Greek parliament and President have failed to arrive at a unified approach to address the country’s debt, with future bailout money resting on Greek acceptance of unpopular austerity measures.  New elections will occur next Sunday which could put in place a government that would reject the tough provisions required to keep Greece afloat. If the new government does not approve of the austerity measures, Greece will most likely be forced to exit the European Union. This could have “catastrophic” consequences for Greece, driving inflation to as high as 50% according to former interim prime minister of Greece,  Lucas Pademos, as well as for the rest of the European Union, reports, Jack Ewing in the New York Times, “Europe Dodges a Bank Crisis in Spain but Perils Lurk,” June 10, 20112.

Even if the new Greek government does persist in fulfilling its end of the bailout bargain, many doubt the ability of a new government and existing institutions to live up to the requirements of reducing deficits an making loan payments. Private equity has begun to flee the country.  And the broader danger is a contagion of financial panic affecting other E.U. countries, the Times explains.

Spain, Europe’s fourth largest economy, is already struggling with massive debt of its own, and has just received a bailout infusion of around $125 billion to keep its large banks capitalized. Nonetheless, Spain’s cost of borrowing continues to rise in the shadow of Greek uncertainty, with adverse consequences for the country.

Europe – On Sunday, June 3, 2012, George Soros put a sobering time table on the European financial crisis, stating that the European Union is “like a bubble” and has three months to correct its mistakes before its fate is sealed. On June 7, 2012, in Yahoo Finance’s “Daily Ticker,” Aaron Task interviewed Professor and Nobel Laureate, Joseph Stiglitz, who felt the Soros’ time frame for Europe was generous.

Stiglitz stated that austerity measures, which have been insisted upon by Europe’s lender countries, are inadequate to address economic downturns. He cites past examples, such as Hoover’s austerity program preceding the great depression, and similar measures of the IMF in East Asia. In each case – as in the current European one – austerity converts downturn to recession, and recession to depression, Stiglitz asserts.

Structural problems- European economic problems are structural, beginning with the union’s formation, which did not emerge from careful economic analysis, Stiglitz explains, but by the initiative of politicians who felt that a common currency would bring people together.  The details of the economic union have never been completely ironed out, and, Europe lacks a unified financial policy and the ability to enforce broad reforms, even as many E.U. countries have become dependent on borrowing.

European nemployment is spreading, deepening E.U. countries’ deficits.  In Greece, one of two young persons is unemployed. In Spain, unemployment is over 22%, according to Stiglitz.

Undercapitalized banks, in the weaker E.U. states face a vicious cycle of currency flight, he goes on to say.  Absent unified European financial control, the European countries are responsible for bailing out their own banks, yet they lack the power to print new currency without immediate restriction, like that held by the U.S. government.  Facing large and growing debt, the Spanish government may simply lack the funds to save Spanish banks, fueling angst, and the flight of capital from Spanish banks.

And Spaniards with falling confidence in Spanish banks can pull out their money and put it into German banks, exacerbating the problem for the troubled Spanish banks, futher weakening public confidence in them.

What is needed – To prop investor confidence and retain capital, Spanish banks need a European guarantee, according to Stiglitz. And so, the person to watch in the coming weeks seems to be Germany’s Angela Merkel, leader of Europe’s biggest economy, whose past insistence on austerity has precluded such a measure.

According to a June 4, 2012 Associated Press article, “German chancellor open to idea of European banking union as long-term solution,” Merkel, this week, gave a nod to the prospect of establishing a European banking authority, saying she was “open” to it. Other reports elaborate that she is also open to the prospect of aggregating European debt – which would saddle the richer Northern European states with responsibility for paying the debt of their poorer sister states, but would stave off the crisis – at least for a while.

E.U. leaders will meet on June 28 and 29 to discuss putting European banks under central oversight, but no concrete proposals have yet been made according to Ewing, and this cannot be a quick fix for European problems.

What to watch for – So watch to see whether the a new Greek government will work to meet austere bailout requirements. Watch to see if Spain requires further bailout money to keep its banks afloat as fearful capital exits.  And watch Angela Merkel and the E.U. summit later in June to see whether Europe will accept shared oversight and shared responsibility for the debt of participating countries.

Contributed by: Chris Campbell
Managing Director
Net Lease Capital Advisors
ccampbell@netleasecapital.com

Acknowledging some positive trends, Dr. Chandan envisions continual lag because of enduring, unaddressed structural problems weighing down on economic growth.

How long after a recession begins does the labor market bottom out? Until recent times, the answer has been: within 18 months. But the aftermath of the most recent crisis saw jobs continue to fall well beyond that time horizon. This has been called a “jobless recovery” because hiring did not begin anew until about two years after the expansion that followed the crisis.

And, now well into the recovery period, Chandan sees little reason for optimism.

As of his telling, employment was still down 3.9% from where it was prior to the crisis, and had not even caught up to its worst levels during the 1953 recession.

Major cities have demand for high skill labor and space. But education is not keeping pace with the demands of the work place, with many college graduates still lacking skills sought by employers.

The construction industry, which was devastated by the financial crisis, created a large group of displaced workers who have showed difficulty developing new skills and finding good training for new trades. This lack of labor flexibility becomes an additional drag on recovery.

Most new jobs have been created in the education and health sectors. However, these growth industries have been driven more by simple demographic shifts than by true economic expansion.

Finance reforms designed to remedy the dynamics which lead to the recession lack teeth, according to Chandan. The Dodd-Frank bill (for Wall Street reform and consumer protection) still lacks specifics, making for uncertainty in the credit and lending industries.

Even so, consumer confidence and spending are high. Dollars are flowing into U.S. bonds, since there is such concern about global stability in the rest of the world. So the U.S. economic and growth outlook is actually more positive than it seems to be for much of the rest of the world. Nonetheless, Chandan asserts it will take a long time to get people back to work in a way that will drive real growth.  And most government interventions to spark growth have failed.  (We are now on our 18th federal intervention to save the U.S. housing market, which continues to falter.)

Consumer optimism has lead to increased new spending, but incomes are not growing in a way that can justify that spending. In fact, Chandan observes they are actually shrinking overall. People are spending more, but the problem is how that spending is being financed. Incomes are shrinking. Savings rates are falling. So the spending is increasingly reliant on credit. “People are tired of deleveraging.” Chandan observes.  And they are taking advantage of access to cheap capital. So the increased spending is critical for growth, but it has not been supported by real job creation or increased incomes.

An ancillary issue is the soaring rate of student debt – to levels never before seen – which is saddling families with debt, earlier.

Chandan also observes a shift in the American way of shopping which underlies this growth of consumer spending that could pose problems. Big box stores are going small box. Bricks and mortar shopping is giving way to on line shopping, meaning less demand for retail space and employment.

The most concerning challenge to sustained U.S. growth, according to Chandan, is the culture in Washington, delaying tough decisions needed to address structural problems in the economy, leaving financial actors in uncertain limbo. This concerns Chandan, who cites the European countries as cases to learn from, with those countries that delayed implementation of tough fiscal discipline now facing more severe hardship, today. Delay comes with a penalty.

So…what should be done?

The government, extols Chandan, should do NOTHING AT ALL!  Of the stimulus measures already in place, he feels quantitative easing and maturity extensions have helped by making yields on risk free investment so low that one must move out beyond treasuries to find any compelling level of yield, promoting more active investment.  And now government should get out of the way.

In the happy medium sought by investors of places to invest where they can both avoid risk and still gain yield, Chandan finds a few notable arenas, including the net lease niche. But within net lease, there simply is not enough core product to meet current demand.

Submitted by: Chris Campbell
Managing Director
Net Lease Capital Advisors
ccampbell@netleasecapital.com

Most U.S. companies lease equipment or real estate for their operations, the study asserts. Generally, it says the changes would depress company profits, retard economic growth and add to financial instability. U.S. companies would add an estimated $2 trillion to their balance sheets, increasing overall debt by 11%. This added debt would affect companies’ ability to gain financing. And elevated debt-to-equity ratios will affect corporate earnings. The study says the proposed changes could result in a $96 billion reduction in the equity of U.S. firms overall.

Front loading, which recognizes greater lease payment expenses earlier on, will reduce companies’ earnings and capital. Balance sheets will reflect more assets (the capitalized leases) more debt, and less equity.

Additionally, companies will need to pay for professional guidance to make the adjustments.
Companies in industries that rely more heavily on operating leases, such as retail, transportation, banking and telecommunications, are likely to bear more of the impact.

A wave of uncertainty will roll over the financial world as key metrics change that are useful for financial analyses such as company valuations, peer to peer performance comparisons, credit worthiness and capital requirements.

“Perhaps the most significant unintended consequence of the new regime could be a shift in the lessor-lessee dynamic,” the report points out. Lessees, seeing a loss of advantage in long term leasing, are likely to seek shorter leases or choose to buy outright instead of continuing their leasing strategies, all creating risk for owner/lessors, and possibly inflating the cost of leasing generally.

Exemplifying these points, the study analyzed the impact that the proposed changes would have had, if they had been implemented in 2010. It found that $2 trillion in assets and a corresponding level of debt would have been added to company balance sheets, and that income for U.S. corporations would have declined by $32 billion, or 2.4% as a result of front loaded recognition of lease payment expenses.

Contributed by:
Chris Campbell
Managing Director
Net Lease Capital Advisors
ccampbell@netleasecapital.com

http://www.areadevelopment.com/AssetManagement/April2012/corporate-sale-leasebacks-low-financing-26262511.shtml

In her Nov. 16, 2011 CFO Journal article “Firms Resist Accounting Plan,” Emily Chasan cites analyst estimates to say that the accounting change would add a total of $1.7 trillion in current liabilities to corporate balance sheets.

Moreover, the proposed measures to equate leasing with buying for accounting would require companies to use “front loaded” accounting, which recognizes greater portions of each lease payment as expense in the earlier years of the lease, just as the interest component of loan payments are greater in the earlier years of a loan.  (By contrast, straight line accounting spreads the expense costs evenly over the lifetime of a lease, like rent payments.)  So companies’ income statements will reflect less net income in the earlier years of a lease.  According to Chasan, front loading also raises lease expenses, over all.  While frontloading can be seen as beneficial for tax purposes, since it results in greater deductions earlier, it might be seen as problematic for companies trying to show higher returns and profitability to shareholders.

Front loading especially affects retailers who rely heavily on leasing property, since they require numerous properties as outlets for their businesses.  (CVS drugstore, for instance, leases 95% of its retail stores according to its own December 2011 report to FASB as sited by Chasan.)  Chasan explains that for retailers, the greater value of a lease is actually found in its later years, since retailers require time to build name recognition and clientele.  So the expensing method does not accurately reflect the way many retailers value their leases.  Chasan cites Bill Bosco, a member of the IASB’s working group on lease accounting.  He estimates that Walgreens, which leases 79% of its locations, would see an increase of 23% in lease expenses in the first lease year, alone, as a result of the front loaded accounting.

Another side effect of the changes is likely to be that companies may seek to reduce lease terms to keep costs down and to reduce the liability they must record, according to Brett Hardy, Colliers International’s head of corporate finance, as cited by Chasan.  This could be disruptive for retailers who need long term presence and could add to their exposure to market uncertainty whenever they look to extend their presence in a given location.  In its white paper, “The Impact on Corporate Real Estate of Lease Accounting Changes under GAAP,” dated Sept. 15, 2010, KBA Lease Services explains that the incentive created for companies to use shorter lease terms will also conflict with lender and investor preferences for long term commitments.

KBA points out additional costs of these changes for companies:  They will need to continually reassess lease renewals and contingent rents.  They will also need new systems and processes in place by the time the changes take effect, especially since leases that are already in existence will still be subject to the changes.

Also, KBA points out that the changes may be unfair in their blanket equation of leasing and buying, with harm to companies for whom leasing is a deliberate part of operations strategy.  Many companies need only limited presence in many locations, and prefer not to own real estate but to keep capital in their operations.  Such companies use leases as a cost-effective way to pay for limited space during particular times, rather than having to own and maintain space, even when it is not functional for their businesses.  In their case, it seems appropriate that lease payments be considered operating expenses, not mortgage payments.

Assessment

KBA’s position is that in spite of their negative impacts, the changes make overall sense in that they put all companies on an even playing field.  They create consistent treatment, for companies which make long term financial obligations for the right to use things, regardless of whether those companies buy with financing, or lease with long term rent commitments.  The changes also create consistent treatment regardless of what kind of asset is being leased, be it widgets or property.  So they do help in making comparisons among different companies, and in making analysis more straightforward.

Continued.

Contributed by Chris Campbell
Managing Director
Net Lease Capital Advisors
ccampbell@netleasecapital.com

Reviewed by Jim McCartney
Managing Director
Net Lease Capital Advisors