12-step program for banks

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Do you have a friend or family member that has had trouble with addiction? Have you heard about "12-Step" programs to get "clean" so to speak?

I have this friend, for the purposes of this article, I will call "Bank" and his problem/addiction if you will is credit. "Bank" has had a tough road for the past 6-7 years. First he was living it up on cheap credit, then he became a dealer and started to consume massive amounts of even cheaper credit. When he ran out of credit he did what any addict does and found other people help fund his problem. In "Bank's" case, it was clear, those funding his problem were not concerned about too much of a good thing. It was kind of funny to watch. "Bank" would go out, lend some money, get a huge fee and a nice buzz as well. "Bank" never failed to find money to lend, as long as there was a fee to be made. "Bank" thought the party was going to go on forever.

One day, "Bank" got a call from one of his suppliers of the cheap credit. After years of providing money without asking too many questions, the suppliers started to notice they were not being paid back. Eventually "Bank" started to notice even he was not getting paid back on the cheap credit he sold. This was not good, for if "Bank" could not use his cheap credit he would lose his fees, maybe even his job. Sniff. Instead of "Bank" realizing he has a problem, he wants to pretend one does not exist. "Bank" is so addicted to large fees and cheap credit he does whatever he can to put his problem off to another day far, far in the future.

What "Bank" needs is a 12-Step Program. There are three things to know about addiction; the treatment is not fast, the treatment is not easy and the cure begins with an admission that you have a problem and your life is unmanageable. American banks are in trouble. The banks lent more than a ton of money on projects, investments and pure speculation. The problem now is that the bank's problem is our problem. Since banks do not want to admit there is a problem, troubled loans stay on the books. The longer these loans stay on the books the less money there is to loan. A side effect of these troubled loans is that the assets remain on the books at inflated valuations.

Here is an example to illustrate the problem: There is a 4,000 sf office condominium where a bank lent almost $600,000 and the owner defaulted. The bank took about a year to foreclose by dragging their feet and today they are trying to sell the asset for $400,000. At first blush that sounds pretty good, only 66% of the original loan amount. The trouble is the condo is in such disrepair and there is so much competing newer space on the market that the value is probably closer to $80,000. The "funny" thing is the bank probably could have sold the asset for $200,000 when it first started the foreclosure. But due to the bank's own delay it is worth only about a third of that today... and tomorrow does not look any better. The longer the bank holds on to this property it will continue to decline into dis-repair and there will be even more space on the market tomorrow. The inaction by this bank and many other banks is hurting commercial property owners. Sure it would hurt the values of all commercial property if the banks had a huge liquidation sale but then the healing process could begin.

By pretending there is not a problem and not admitting first, there is a problem and second their books have become unmanageable, the cure, the rehabilitation cannot begin. The FDIC said a few months ago they wanted the banks to stop playing "Delay and Pray" with their loans and assets. What the banks need is for the FDIC to require all banks to acknowledge say 20% of their troubled loans each year for the next 5 years. Otherwise we risk going the way of Japan where banks made loans that became troubled loans and instead of facing the music they held the loans at face value and have continued to pretend for the last 20 years that values will eventually catch up with the loans and everything will be okay. By not admitting they had a problem Japan's banks have dragged down their economy for two decades with still no cure in sight. What we need is for banks to admit there is a problem, take action to make their books manageable and liquidate the assets so we can all get on with our lives.

Unconventional Wisdom

I had lunch with an investor friend of mine on May 18 and we had a very interesting discussion about the economy in general, real estate prices/values and the stock market. First let me say if a man is measured by his friends then I am the richest guy in the world. Not only are my friends smart but they are generous with their time and allow me to probe their thoughts on what is happening but also why it is happening (in their opinion).

My friend sees the general economy as sluggish and thinks it will continue to be flat for some time. He sees much trouble ahead for the commercial real estate market. It may be because there is too much space and not enough tenants or consumers may not be spending enough to keep the tenants in place. Regardless, he sees cap rates heading back to the historic mean of 10%. In english that means retail/strip centers may fall as much as 40% in value from 2006 prices. Compounding the situation is many centers are not stable as in they are not 90% full and most are losing tenants such as Circuit City, Linens & Things and other bygone companies.

On top of that, rents are still falling in centers across America to entice tenants to move from one center to another. Plain and simple, the commercial market IS ugly and will get worse. I have to say I agree with my friend. With that said, I also have friends in areas that are not overbuilt and their centers are staying full and rents are stable but these are in less populated areas.

As for the stock market, I keep reading about how much cash is sitting on the sidelines ready to invest in anything that makes sense. I was talking to my friend about a graph someone sent me that showed money market deposits as a ratio of the S&P and it showed a monster amount of available cash. My friend pointed out how the graph misrepresented the actual amount of available cash because the S&P index is down by almost 50% since a year ago. Therefore there is not twice as much cash as a year ago as the graph indicated, it is more of a reflection of how the S&P is down. My friend really likes SRS (Super Short Real Estate Index) and I will tell you I am also a fan of SRS and I own it as part of my own holdings. All of my investor friends believe the stock market is over bought and we are in a secular Bear Market that just happens to be in a rally.

Back to real estate in general. One thing my friend has been saying for some time now is do not buy (for investment purposes) anything for a year or so. He believes the prices will be the same if not lower a year from now and the chance of further decline is just not worth the risk of marginal returns (rents) and carry costs such as taxes and insurance. In general I agree with him but there are always exceptions and one should keep their eyes peeled for those exceptions (i.e. some distressed bank own property for example). It also depends on why you are buying too. If you are buying to use for your own purposes, then there is no risk of lost expected rental income and you will pay taxes and insurance wherever you live or run your business.

In closing I hope everyone has a great Memorial Day weekend. Stay safe.

What is a Home Worth?

As long as the moon has been circling the globe the tide has come in and gone out. When the tide comes in it raises all boats. When home prices were going up all real estate went up just like boats in a harbor. Today as the proverbial tide is heading out, the question really is "How deep is the water"? That is, as the tide heads out, have we hit bottom or is there still a ways to go? From where I am standing there is no bottom in site. At the end of the day I think a house is worth what you can do with it.

I was speaking at a ULI program recently and I made a statement there that I will repeat here; just because a home on your street was sold for $25,000 does not mean your home or all of the homes on your street are now worth $25,000. I also stated that I am seeing a correlation between 2005 selling prices (not listing prices mind you) and selling prices today. That correlation is the value today is about 1/3 of the 2005 selling prices. It is not a perfect relationship but I keep seeing it over and over again.
With that said, if you have a home with a mold issue and it cannot be lived in then that home is not worth much. If I can rent out a home for $1,000 net per month then that home is worth considerably more.

A friend of mine was driving though Georgia a few months ago and ran across a home in a remote area that appeared to have been built with expensive materials. My friend shared with me that he thought the house was a terrible waste of money. So what is the value of a remote "expensive" home? Maybe zero. Maybe some. Probably not what was spent to build it. My point is some houses will never be worth their construction cost and no minimum price exists. The bottom line is if a home has utility, it's forward value will be based on that utility.

What is Land Development Consulting?

Many people ask what I do for a living when I meet them as I am sure happens to you. I tell them I am a land development consultant which results in a puzzled look followed by a "huh?".

I briefly explain my background in civil engineering, planning and development to them and I tell them that I use my experience to help those less familiar with the development process. This leads to a sigh of relief from my new friend and a comment such as "oh, so you are a builder?" or "oh, so you are an engineer?".

Okay, yes, I have done both of those things but I offer so much more! More time with your family, more money in the bank and more neighbors happy to see you. Let me explain it this way; my son loves to turn all of the lights on in our house but cannot remember to turn them off. We are trying to teach him to turn lights off when you are not in the room. Much of the time he forgets to turn the lights off even though we remind him all of the time. We have implemented a new strategy in our house to help him remember to turn the lights off - we charge him a quarter for every light he leaves on! We explained to him that electricity costs money and since we are getting charged, he is going to get charged. A few nights ago we took two crisp dollar bills from his piggy bank to pay for the eight lights he had left on up stairs. To say he was upset would be an understatement. He did not want to see his money leave his bank. I am sure it will happen again since he is only six years old, but let's just say he has not left a light on since then and he has even reminded us to shape up!

The purpose of sharing a personal story with you is to convey the point that until something costs YOU money, it really is not very important. A developer will hire an attorney, an engineer and a planner and assume these professionals will tell them all they need to know for a successful project. You have to admit it makes sense. The problem is there are many ways to spend money when developing a project. There are many ways to lose money on a project. Who does it hurt in the long run? The attorney? The engineer? The planner? NO! It is the developer that pays.

What is the incentive for any of these professionals to learn how to not cost you money? A very good (and rare) professional may advise you on a subject within their specific area of expertise such as a title issue, a drainage issue or a zoning issue, but which one is going to warn you (before it is to late) the neighbors will fight the project if you do or don't do something? Which one will tell you why you should avoid asking for too much density in a rezone case? Which one will explain how the timing of a project can mean huge savings?

A land development consultant has been "there" and has spent their own money on unnecessary issues at the direction of a "professional" They have had situations where they were told "don't worry about it" and it cost months of delay at a cost of $25,000 per month. A land development consultant has watched as one professional after another has said "they have to approve this" and then seen the project denied approval.

Can you imagine a football team without a quarterback? There is a lot of talent on the field but without a leader, someone to call the shots, the talent is misused or underutilized. At worst, a land development consultant is an extra layer of review and additional costs. What is so bad about an extra layer of review from within the team? While money is always tight, is an extra $30,000 in land development consulting fees on a $12 million project significant? If that $30,000 in "extra fees" saved you three months of interest carry would it be worth it? You bet. I am here to help those in the development industry and those serving the industry such as banks and investors. Are you unsure if you need my help? Give me a call or email and tell me what you are thinking of doing and I will give you an answer on the spot - no strings attached.

Why make mistakes that can be avoided?

Let's Make Hay While The Sun Shines

Remember when everyone was making money hand over fist in the real estate market? Boy the sun was shining then. Now that it is raining cats and dogs in the real estate market, I believe the sun is shining for investors. Sorry to mix my metaphors. I will not go out on a limb and say this is the perfect time to buy because "perfect" means different things to different people. Some investors are looking for income producing properties, and others are looking for an end return on their investment.

With that caveat behind me, I will say this; it is the perfect time to look for/at whatever type of property appeals to you. The market will be flat for some time, so many will want to wait for prices to move up before they buy. I respect that. However, the best properties will be purchased and therefore off of the market first. As prices rise it will be the inferior properties that will be left to choose from. The sellers and developers I am talking to are increasingly willing to deal if you have cash and a quick close. We are emerging from the winter of real estate market cycle and headed into spring. Spring is the time to sew our seed for future harvest. As investors we take on risk, that is just part of the job. That does not mean we need to take on unlimited risk. We can measure risk and take steps to mitigate for present or future risk. If you are concerned that you may buy something too soon, then you may want to take on one or more partners to share that risk with you. Another way to mitigate risk is to only buy when the investment pays for itself in terms of cashflow. The way to make money going forward is to NOT take large risks but a lot of calculated risks.

The market of 2005 is gone forever. It was too good to last and was therefore destined to end. There is nothing wrong with assets that do not double in value every year or two. While the stock market has been trading sideways for the last 6 months I have been buying stocks and selling options against those stocks to lock in a 25% return. In some cases I made 25% and in others I only made 25% while the stock doubled. My point is this; if you protect your principal with risk mitigation, there is nothing wrong with double digit gains. So, while it is raining cats and dogs, let's make hay while the sun shines. I am telling you the future is so bright we will need to wear shades.