Real Estate Tidbits

CMBS (Commercial Mortgage-Backed Securities) posted the highest delinquency rate in history in January. CMBSs are bonds, sold on Wall Street, which are backed by mortgage income from commercial real estate. According to Trepp, LLC, 9.34% of loans in all CMBS are 30 or more days delinquent; the value of these delinquent loans is $61.4 billion. Although the rate of increase of delinquent loans has slowed over the last few months, the rate of delinquency continues to climb despite considerable new issues which should be stable at least n the near term.

The credit profile of most Americans improved substantially in 2010. According to TransUnion, its Credit Risk Index (CRI) was 3.13 % lower at the end of 2010 than the reading in 2009; all states except Wisconsin improved its CRI. Wisconsin already has a CRI substantially blow the national average. Officials note that this change is a very positive sign regarding the housing industry and consumer spending.

Home ownership is still the dream of 70% of Americans according to Trulia.com. Despite the housing morass, 78% of homeowners think that their home was the best investment they ever made. Interestingly, 88% of renters 18-34 years old plan to be homeowners. One in four of these young people has become more positive about homeownership in the last 6 months. This is a very positive sign for housing in the years ahead.   

Developer’s Risk and the Art of Flying

I think the media and the community at large should stop vilifying developers. That sort of behavior parallels calling all UT football payers thugs, which is ridiculous. (I recently met Inky Johnson, the former defensive back at Tennessee whose career was cut short by injury. If there is a more thoughtful, thankful, and caring individual in Knoxville, I do not know who it is.) In fact, developing real estate is a lot like playing football. There is the hard work, the cachet of the activity, the benefits, and just as real, are the risks – of injury or loss or failure.

Jump out of a 50 story window sometime. For 45 stories you might convince yourself you can fly. Certainly by the 5^th floor, you start to rethink your invulnerability, particularly if you made no plan for anything other than flying. Developers routinely take these types of financial risks. They hope and expect that that their plan “takes off and flies” just the way you hope your next putt goes in or your lottery ticket pays off. The difference is that in most endeavors the risk is known and limited. This is not always the case in real estate development. When a developer suffers loss or setback, it can be quite dramatic and public. And it can bring out the worst in people.

The truth is that most developers are really good people who support the community in a number of ways both publicly and privately. I have personally seen these folks delivering food at Christmas and teaching developmentally disabled children how to play softball, as well as many other selfless acts. So, I am a little discouraged when the community takes too much delight in the failures of real estate developers because they are perceived to be undeserving of their successes. There. I feel better now.

The Tale of the Baskets

 These days, just about every banker I know needs to talk about their difficulties in responding to requests for loans. I call this their Tale of the Baskets. It goes like this: a bank regulator visits the local bank and proceeds to separate the bank’s loan portfolio into different baskets. Commercial real estate loans get placed in one; inventory loans in another; receivable loans in a third; commercial and industrial loans in a fourth and on and on until all the bank’s loans are separated into categories. The loans in each basket are totaled, and then… and then, the bank examiner tells the banker which baskets are too full and, therefore, limiting the banker’s ability to make further loans in that category. Guess which kind of loan nearly every bank in Knoxville has too many of – commercial real estate loans. Congratulations if you are able to figure out which banks in the area are not overloaded with commercial real estate loans. The simple truth of the matter is that real estate lending has been very very profitable, and lenders were eager to make the loans. Now, the bank regulators have determined that the banks made too many risky real estate loans even though the regulators were complicit by relaxing their oversight during the good times and encouraged excessive lending with a wink and a nod.  

We’re Still Lending

Despite what you might think, bankers desperately want to loan their money. I’ve heard people claim otherwise, and that contrary view is almost believable. I make .2% interest on my savings account; the bank can invest my money in Treasury Notes at up to 4.5% (if they buy 30 year notes). The fact is that the banks need to work their deposits more vigorously, actively and profitably to pay for their operations and return money to investors. That’s where loans are important. Unfortunately, many of their baskets are full. However, just about every bank in town is looking to place loans for owner/user transactions. These are real estate loans for acquisition or construction of buildings to be occupied by their owners. If you are a doctor or a dentist or other professional looking to own your own facility, call me. We’ve got choices. If you are an investor looking to build speculative office or industrial space, just have a seat on the bench. Your time will come………..Bring a sandwich; it will be a while.

Knoxville’s Newest Cottage Industry

Aristotle’s observation that “Nature abhors a vacuum” was rooted in scientific observation, but it is true also of the marketplace. There is currently a critical and unfilled need for commercial real estate lending. Lots of loans were cast in 2005, 2006 and 2007; many of these loans are current but cannot be renewed by the original lender because of a given bank’s basket (see above). Not all of these loans are good ones, but some good loans will be called for additional equity or full payment (or foreclosed on) because there are few banks that can accept them. The banks with capacity for real estate loans are taking care of their best customers or seeking the absolute best properties. In this vacuum, there is a growing market for private lending where individuals or investment groups place loans where bank lending is unavailable. These individuals are selective, they are conservative in their underwriting and they charge slightly higher rates than a bank might, but they do loan. I know of a couple of people who are very happy and relieved that this alternative was available to them. I do not know how large this cottage industry will get in Knoxville, but I believe that the opportunity for this type of lending will flourish until the banks are able to resume their normal function of providing funding for real estate acquisition and development.

 

 

Gordon Food Service and the Dawn of a New Age

Some very close friends of mine who currently are shopping around for a loan. They own a large vacant office building which is arguably worth  about $3,000,000; it would require much more than that to replace it. The owners are looking for a $400,000 loan to replace some unfavorable, existing debt. That is all they owe on the building – something less than $400,000. Even with a very conservative appraisal of the property, a lender would be funding a very small percentage of the value. For instance, if the lender agreed that the building had a value of $2,000,000, their $400,000 would represent only a 20% loan to value. This is the very heart of how real estate lending is supposed to work. A borrower comes to a lender offering real estate as collateral for a loan. A commitment to lend is provided by the lender based on certain terms - rate, term, amortization, loan to value (LTV) and receipt of an arm’s length appraisal of the property. Done deal.

The problem is that over the last few years, property values have dropped. A loan that once carried a LTV of 75% in 2006 now may be a 90+% LTV. The value of the lender’s collateral has dropped in step with this trend. Borrowers are not the only ones who can find themselves underwater. Consequently, asset loans, loans based on the perceived value of something are a little hard to arrange. Or am I being too subtle? Among many lenders, asset loans are toxic.

That’s why the news of the Gordon Food Service purchase of 1 3/4 acres on Kingston Pike for $1,000,000 per acre is so positive. Finally, we are seeing signs of appreciation, or at least stabilization of prices of prime real estate. Over the past few years, values have been dropping and licensed appraisers have had to use those dropping property values as comparables to fix values for newly appraised properties. Please understand that appraisers are not villains here; they are bound by the data available to them.

But think for a minute. Gordon Food represents a new trend – prices stabilizing, even increasing. Now we have a new comparable. A few more, similar transactions start to make a trend. Appraisals will reflect this trend. Bankers may decide that the risk of holding real estate as collateral has diminished and allocate a larger percentage of their funds to real estate loans. Think of it. Developers and investors fully engaged in their work. Architects and contractors fully employed. The possibilities boggle the mind.

When Gordon Food Service opens for business, I think I’ll go in and thank them.

More Than You Wanted to Know About Fungibility

This past Friday afternoon, I was visiting with a broker friend and three industrial developers over a beer when the subject changed to Kroger, Knoxville’s currently reigning real estate villain. As you may know, Kroger purchased a parcel of land adjacent to their existing Marketplace store on Kingston Pike near Cedar Bluff with the intention of building a new store (presumably abandoning the one they are operating now).

According to one of the developers, it is a scandal that Kroger would pave another greenfield site when there are so many vacant “big boxes” they could renovate and expand, if necessary. Besides, the Marketplace store is perfectly adequate, he opined.

 I am not able to comment on the adequacy of the store or the internal operations of Kroger; however, my friend, the developer of industrial buildings, had completely overlooked the idea of fungibility. Subject to zoning restrictions, site functionality, transportation considerations etc., an industrial building can be sited anywhere. Kroger, on the other hand, must evaluate the additional requirements of visibility, traffic patterns, demographics and others to identify a successful location. Simply put, the location of a Kroger is non-fungible; the average industrial building is much less so.

Besides, I am firmly convinced that Kroger’s decision to purchase/ develop this property and move its store is largely a stratagem to safeguard market share by denying one of their competitors the opportunity to out position them. Kroger has long been the dominant grocer in Knoxville, but the expansion of Food City, Walmart, Target, Fresh Market. EarthFare and Aldi, and the rumored entry of Publix, Costco and Trader  Joe’s, threatens their share of the grocery dollar.

The Legendary $1,000,000 Sale

Recently, a friend of mine, Pamela Treacy, brokered the sale of 1 3/4 acres of commercial property on Kingston Pike just west of Cedar Bluff to Gordon Food Service (GFS). The sale was reported in the newspaper. Omitted from the article was the fact that GFS paid $1,000,000 per acre for their site.

There have been other sales of a million dollars per acre - the site just west at Peters Road and Kingston Pike where Walgreens is located comes immediately to mind - but, in this time of reduced sales and lower prices, this transaction certainly raised some eyebrows. It is also a wonderful starting point for a number of conversations about real estate and its value.

Let's talk about fungibility. Everyone has heard the old expression that land is valuable because "they ain't making any more." Those of you who have driven across West Texas, New Mexico,  Arizona, or from Nashville to Memphis for that matter, know that they may have quit making it, but the current need seems to have been adequately satisfied. What is in short supply is the "McDonald's Corner." Feel free to substitute "bank corner" or "national drugstore chain corner" or "gas station corner." These are the 100% can't miss retail locations in heavily trafficked areas at signalized intersections. Companies will pay large sums of money for them. That's where non-fungibility is important. A commodity is fungible if it is interchangeable with any other unit of the same commodity. A barrel of oil or an ingot of gold is fungible because it can be exchanged freely with any other barrel or ingot. Real estate is non-fungible, and values are set based on the fact that no two pieces of property are interchangeable. One property may be worth $1,000,000 per acre because of its location, zoning, accessibility, usability, traffic count etc. It is doubtful that the property located a three iron away enjoys the exact same valuation. It could be more or less valuable based on the variations in the metrics.

 At the intersection of Peters Road and Cedar Bluff there is an Applebee's on one corner, Puleo's on another, a vacant bank building (soon to be Smart Bank) on the third and undeveloped land on the last. Why is there a vacant lot at the southwest corner of this intersection? Simply because traffic queuing at the stoplight in order to enter I-40 East backs up beyond the property boundaries making it very difficult and time consuming to access the site from Peters Road (Parkside) which currently is the only entrance point into the site. Functionally, the site is not as usable as the other three even though the location is identical. Would you trade the northwest corner (pre-development) for the southwest?

I happen to really like my house. I live across the street from a park, and I am close to work and a really good grocery. It is a small house, but it suits me.  I would not have bought this house if it were moved two miles in any direction. That is the lesson of non-fungibility.

On the Roads...Again

TDOT recently released the latest update to their three year plan outlining road building projects that have been approved to commence between now and fiscal year 2012/2013. Road building in East Tennessee has slowed due in some measure to the gargantuan size of the recently completed I-40 Smartfix project and reduced gas tax receipts because of the recession, increased CAFE standards and the growing popularity of hybrids. (Will electric cars be able to populate the highways without usage fees?).

Despite the slow down, there are some road projects that will affect our lives, most notably the rehabilitation of the Henley Street Bridge, which will be out of service for years.

If you are so inclined, the following link takes you to the entire list of projects statewide.

http://www.tdot.state.tn.us/Chief_Engineer/docs/2010-2013Program.pdf