Real Estate…just when you thought it couldn’t get worse
by Richard
I think life would be much simpler if I didn’t read so much.
Last time I bothered to count there are some two dozen investment periodicals that inform my point of view.
One of the best is Forbes.
No, not just because I am part of their finance blog network. Forbes is fearless about biting the hand that feeds it. It will root out and expose scams no matter how high up the food chain it reaches.
Which brings us to their July 21, 2008 cover story, “The Other Real Estate Disaster,” that opened up disclosure on the murky world of private real estate partnerships.
To get an idea of the magnitude of this issue, you must combine the worst of the excesses of the hedge fund industry with the spectacle of major players overpaying to buy commercial real estate at the height of the bubble.
You’ll need to digest the entire Forbes piece to survey this saga in its entirety. I’ll just give you the high points to whet your appetite.
1. First came the bubble in commercial real estate.
Like its cousin, residential real estate, it was born out of the ashes of the tech stock debacle beginning in 2000.
There are parallels as well as distinctions with residential real estate. Instead of borrower’s liar loans and inflated appraisals, there was an across-the-board lowering of loan underwriting standards by the lenders.
To compete for loan business, the cap rate (yield) on commercial properties steadily decreased, which had the effect, at least temporarily, of boosting valuations on the same financials.
The excesses kept piling on. Instead of valuing a building at a multiple of existing lease income, valuations crept up prospectively in valuing anticipated, future rents.
Once you start discounting the tangible present in favor of a neverland future, you are deep in Enron country.
2. State pension funds got involved.
They were anxious to buff up their rate of return to make up for the dismal performance of equities and clamored not to be left out of the deal flow.
Like the pathetic wannabes kept behind the rope line at the trendy clubs, they begged the bouncers to let themselves in, so that they could mingle with the beautiful people.
3. The Result: Hordes of public pension funds buying at the top.
Complete with multi-year lockups and paying the full freight of engorged hedge fund fees.
And then they went one step further. They were asked to sign non-disclosure forms and confidentiality agreements that prevented them from disclosing basic facts.
This is negligence and malfeasance at an unimaginable level.
There are no trade secrets in buying, leasing or selling commercial property. We’re not talking about gene-splicing or quantum physics or anything remotely scientific and unique
The purpose of these confidentiality agreements was to make the already opaque nature of private partnerships even more obscure and remote.
What we do know is that the returns have been anemic at best. Not surprising, given the overhanging burden of servicing the redundant fee structure.
The REIT Way of Doing It
The irony is that access to real estate was readily available, at nominal fee structures, through the REIT (real estate investment trust) structure, which is a non-taxable conduit for real estate income.
These REITS now are covered as both domestic and global asset classes, and can be focused on any of the major property types desired.
So how did this come to pass? In the usual way. The slicksters who sold the deal were adept at pulling in the public fund managers. The relatively unskilled and unsophisticated buyers were drawn into the refined and rarefied atmosphere of running with the big dogs.
And what if they did grossly overpay for such an underperforming investment?
It’s not like it was their own money they were playing with.
