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Investing in uncertain times: TIC perils

About a year ago, my company's founder was quoted in the press, talking about real estate and sex. Before I had a chance to read the paper, there were six messages on my voice mail. Customers and competitors laughing hysterically, asking how he had the guts to say something on the printed page. He left me mortified, wondering how a grown man and business leader could compare real estate to sex. But, compare it, he did. At the time, I thought he was acting the buffoon, looking to shock and amuse a bored readership, or, himself. The furthest thought from my mind was that he might have meant what he said. Jumping into real estate is like jumping into sex, nothing happens on the sidelines. Even further was the idea that he might have been right.

The reporter called to ask him about investing in TICs. In last year's economy, TICs still were safe bets as passive real estate investments. They promised a return like a REIT but instead of owning small pieces of stock representing snippets of a large real estate portfolio, TIC owners actually owned property. It might have been with 30 or 50 other people but TIC investors owned dirt.

Our founder claimed that real estate, like sex, is not a spectator sport. Interesting comparison, possibly compelling, but most likely stupefying to the casual reader or non-investor. However, the meaning behind his words have been born out in the past couple months.

Real Estate is a hands on project, whether your own or those of an accomplished, manager for both facilities and income stream. When the fortunes of economy change, a Landlord/owner/developer needs to see the change, anticipate an slackening of income and potential blow to the profit and loss statement. As a TIC owner, one generally has a limited amount of input into the management of a property. Decisions are made by a minority representing the majority. While the decision makers may keep you in the black through a recession, it isn't likely. It's not likely because they work with consultants who are paid employees, receiving a paycheck each week regardless of the property's performance.

Individual landlords or partnerships are more likely to be proactive in a changing market. They are paid when the bottom line balances on the plus side. Vacancy in recession is a Landlord's true enemy. Suddenly maintenance of the space, as well as advertising, marketing fees and operating expenses populate the negative side of the balance sheet. The bottom line does not love money flowing out. The wise Landlord mitigates vacancy.

Whether the owner of a large retail shopping center decides to suspend percentage rents for a period of time, or revises "go-dark" clauses in the leases to allow tenants to reduce employee costs is entirely up to the individual owner.

The list of proactive solutions to tenancy go on and on, for instance a Landlord in Illinois whose largest distribution tenant is Schneider Electric, the world's largest maker of circuit breakers, may negotiate a rental abatement, credit or brief reduction in rental payments. Headquartered in France, Schneider exports large quantities of product to the Emerging Market countries (BRIC - Brazil, Russia, India China). Emerging Markets have been taking a beating in the global credit crisis like everyone else. China which has expanded 10% every year for the past five years is slowing down. The Russian government has pledged $200 Billion to stop the bleeding in its worst banking crisis since 1998.

Ultimately, a landlord may be wise to renegotiate a lease with a leader in world manufacturing if the Landlord understands the world markets and the reality that Europe was increasingly exporting goods to Emerging Market Nations since 2000. Real Estate holders whose soul investment are in TIC's stand to lose in this market, not the same way that shareholders in REIT's with under performing portfolios will ache, but the inability to be proactive and think outside the box to maintain a positive income stream and return on equity will cause the average TIC holder sleepless nights and a knock to the wallet. As it turns out, Real Estate is not a spectator sport.


October 27, 2008

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Warnings: Deflation, Steel demand down, the Dow down, China down. Still the Economy can Rise.

Suddenly, predicting the country's financial future is as scientific as reading tea leaves.

We are in uncharted territory. Never before has the government owned so much of the "private" banking industry. World stock markets continue to fall. Each small gain is corrected by a loss two times as deep. What began as bad lending practices in the United States mortgage industry has become a world wide economic downtown.

The government is attempting to intervene and control the markets, the same thing it did before the Black Tuesday in 1929. Only back then, the Federal Reserve raised interest rates to discourage the booming stock market, only to drop them rates from 6% to 4% four months after the crash. Interest rates are again falling.

Is this really a parallel? A harbinger? It's certainly being argued that it is.

The only thing that can be known for certain is that since the turn of this new century, Americans have been living in a "Minimum Payment Economy. Living on credit, planning for a future when income will outstrip personal spending by virtue of imagined wage increases. Though predatory lending practices were certainly widespread throughout the mortgage market, particularly in the subprime arena but elsewhere also, these practices could not have flourished without a consumerist "gratify today, figure out how to pay for it next year" mentality and economy.

After the 1974 recession, the worst since the great depression, the personal savings rate was 5.1% alarming at the time. In the early 80's it rose to 5.8% but after 85 it plummeted to 3%. Think Oliver Stone's Wall Street, Gordon Gecko declaring "Greed is Good" and the "Me" generation.

1990-1991 saw another recession, a recession that crippled New England closing banks, driving our manufacturing south and sending unemployment into double digits. In Connecticut, the recession began in 1989. We didn't recover until 1992.

Our state history mirrors the nation's recent off-shoring of manufacturing jobs. India and China are the New South. Technical jobs and skilled labor continue to dwindle.

One wonders what the new century has wrought. Personal savings in 2005 was negative 1%. Currently it hovers under 3%, but it is on the rise and in fact is touted as soaring. Soaring because the savings rate in 2006 hovered around 1% and dropped closer to zero in all four quarters of 2007.

So, in 2008 personal savings of 3% is a breakthrough, in 1987 a disaster. Yet this time around Americans aren't greedy the McMansion buyers and credit card shoppers are duped and hoodwinked. Same net result, only repackaged: self indulgence and instant gratification in a non-judgemental world.

Worldwide, demand is down for commodities. OPEC laments falling oil prices. The steel industry is down, indirectly signalling a slow down in China's construction market. Two years ago, China consumed 40% of the world's steel.

Domestically, there are warnings about hedge fund sell offs. Other warnings are the rising unemployment rate. It's at 7%. The crippled domestic auto industry. The energy industry. What will the ripple effect be hedge funds sell off their stocks and flood the market, if they flood the market? Will grocery stores suddenly be unable to stock shelves because their stock will drop to the floor? Will the big three car makers disappear altogether?

REIT's, Real Estate Investment Trusts, which own large portfolios of real estate paying out dividends and returns to shareholders have artificially driven market prices up over the past five years, intensifying in the past three. But, now, there aren't any checks in the mail heading into REIT headquarters. Promised returns are not being achieved. What happens when they sell off assets and large tracts of property, hundreds of thousands of square feet of distribution, office and warehouse space? The short answer is that local entrepreneurial investors will be able to buy property for its true value, but will there be a demand? Is their cash well enough in reserve to keep commercial real estate values from tumbling?

Doomsday predictions are in Vogue, but is there an upside? Yes. Maybe this is the wake up call that we as a country needed.

Maybe the government and citizenry will realize that the United States can not succeed as an economy that simply consumes. Now is the time for venture capitalists, hedge funds and cash holders to invest in those niche products that only we can sell.

We gave our old economy away. Industrial, manufacturing, sewing, call center operations are gone, but there are new frontiers in medicine, stem cell research, fuel cell technology, nanotechnology, gene therapy to be explored. While our political system may prevent us from taking advantage of these breakthroughs we can and should sell them.

Once again, we can sell to the world instead of eating everything it produces. After the Great Depression, the war machine and the war economy were heralded for righting the Great American Ship.

In truth we were making and selling what the world needed and couldn't produce, so this time, instead of producing tanks, planes and bombs for the United States, and our old allies, it will be a reclamation of American ingenuity, technology, cutting edge software and medical techniques.

If only we heed the wake up call and trump doomsday.

October 21, 2008

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Borrowing from ourselves: reverse mortgages the next honey trap

There is already a new record. That record? Reverse Mortgage borrowing.

In 2008 the amount of reverse mortgages increased by 4.2% over last year. That may not sound like much but it's a good bet that there will be exponential growth in reverse mortgages next year.

Originally intended to give elderly homeowners without mortgages or with a lot of equity in their homes, a vehicle to liquidate some of that equity into cash for use in their twilight years, whether they use it for home health aides, hospice or dream trips.

In a reverse mortgage, 62 year old or older homeowners can tap into their home's equity by getting cash in a lump sum, or monthly income, a line of credit, or some form of all of the above, without having to sell or give up title to their houses. The money is tax free, and repayment is made only when the owner moves or dies.

Banks like them because they are front loaded with fees, meaning that they are profitable to write in the short term. The owner is charged points and closing costs upfront (this is on money that they've already paid interest on as they were paying down the original mortgage) which is profitable for the bank. Rather than dwell on the cost of each dollar that the homeowner is borrowing from themselves, there are more concrete cons to the reverse mortgage. The proceeds might actually prevent the homeowner from collecting medicaid since loan proceeds are counted as assets in certain states.

Also known as Home Equity Conversion Mortgages (HECMs), reverse mortgages are insured by the Federal Housing Administration, an arm of HUD.

In 2005 there were only 43,131 reverse mortgages completed in the US. Cut to the end of 2008 and 112,100 reverse mortgages. As part of the Homeownership and Economic Recovery Act of 2008, HUD approved a single national loan limit of $417,000 for federally insured HECM reverse mortgages that is expected to be effective around Nov. 1. Nearly 30 percent more seniors will be able to borrow through a reverse mortgage because of the higher loan limit.

Though there are pitfalls to the reverse mortgage, they are gaining in popularity and one can imagine that as the adult children of senior citizens suffer from credit spending, ARM backlash and bank bailout busts, borrowing from Mom, Dad and their home equity will be more than a little tempting. After all, you can't take it with you.

Another concern about reverse mortgages is scam artists. A bank won't have to hold a mortgage for a 77 year old for as many years, statistically speaking, as a 62 year old. But, who might influence the 77 year old to borrow in the first place? Unfortunately, there are plenty of people on the street looking to get paid for interacting with the lonely and fragile.

If that's not enough, make way for the next wave currently typified by Rex & Co. and their Rex Agreement. There aren't any points or interest as with the reverse mortgage, instead you are treated to a silent partner in your home ownership. The agreement lasts up to 50 years, depending on state of residence or until the home is sold. After paying cash for a portion of the home, Rex & Co. share in the profit, or loss at sale time. Rex & Co. are in it for the long haul. Even in a real estate slump, five, seven, ten years can cure price drops.

Watch the news, in eighteen, twenty four months, we will hear rumblings that Americans are again tottering on the edge of a borrowing precipice.


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October 15, 2008

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And the Dow jumps back

The Dow came back today: almost a thousand points in a day. 936 points. Last Thursday the stock market had its biggest loss and today, five days later, it's biggest gain.

The rally was fueled by confidence. Confidence in the government working to improve economic policy and implement bank safe guards, such as guaranteeing bank to bank loans, as well as European governments working to shore up their banks fueled the bounce. Unlike the United States, the British government pumped their bailout money into banks within five days which added to the positive vibes on Wall Street. Investors rallied on confidence and short sellers, who did their part to submarine the stock market by betting against the market and banking on stock losses had to buy as the day went on. Today, everyone was buying.

Is this a one time bounce or the beginning of the end of the bear market. Chances are, tomorrow the market may not continue this rally. Investors may sell, now that they've made some money or made money back.

Good news for the stock market is good news for everyone. But, a thousand point gain in a day is not going to instill long term confidence in the investment world. Slow steady growth without drops will allay fears, rebuild consumer and investor confidence.

While stock market investors, hedge fund managers, day traders and retirement account holders rejoice over the gains, real estate investors may not be jumping yet. Investing in real estate, traditionally is a long term hold proposition.

While home values doubled and tripled in record time, the manic market is not the arena of the commercial real estate investor buying office, industrial and retail properties looking for a steady return over 10 or 20 years. But, individual investors also keep their money in stocks and every time the Dow dropped over the past few weeks, investors' money became less valuable. So, there is a hesitancy in the real estate investment market.

Meanwhile, no matter what the politicians and pundits predict, americans need to keep working. Companies need to keep the lights on, call centers need to keep operators busy, hospitals, universities, research labs need to keep looking for ways to beat cancer and other disease. And governments need to keep serving the community. All these institutions need a place for their businesses to live.

That means that, despite the blips, despite the hurdles and the questions, real estate is still the place to put your equity.

The returns may not be as large as Wall Street when it's in a boom, but the losses aren't going to happen over night, or in a month either. Owning real estate is a safe bet, still a marketable entity and still the place where 7,8,9 and 10% returns on equity can be realized every day of the week. The savvy investor will watch the trends, consider what investment markets world wide are doing and take their cues from those markets, investing where they see gains for the next 10 years.

The United States will always be a consumer market, retail space though out of favor now, will be a bet for the future, especially ten years from now. Today, it's great to be a "flex" space Landlord. Whether an office moves from the central business district to the suburbs as a cost saving measure, or a distributor lands a new contract, the "Flex" landlord will have the space to lease. Office space needs will continue to evolve with technology and a backlash against executives, corner offices, perks and parachutes, but office landlords who can easily refit their space, flexible duct work, sprinkler systems and demising walls, will earn their best returns.

Mixed use property owners and residential property owners will continue to have tenants, though nerves are running high now as rent checks come in late. Still real estate, commercial, residential, industrial is a good bet. The investor with the right consultant and guidance will find plenty of returns as the stock market drops and rockets. -kristin

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October 13, 2008

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Rock Beats Paper this time. Real Estate beats stock paper

The stock market is a roller coaster. Freefalls followed by slow climbs up a lift hill. In the midst of the panic, some investors are asking where they would put their money if they pull it out of the market on the next run up.

Treasury Bills are down, the fed is talking about depression era adjustments to interest rates and the buy back of commercial paper. But, landlords who have owned property, bricks and mortar for the long term aren't in a panic. They don't want to see their tenant companies lose business whether they are office building owners or light industrial building owners. Retail strip owners and mall owners are having an attic of nerves. Tightening credit markets means less non-essential spending at Sephora, Bed Bath and Beyond and Auto Zone. The retail market and it's investors will have a rough ride ahead. It's likely to be a slow Holiday shopping season. Cash is king and when cash is king, impulse buys drop.

But savvy investors will see opportunity in this market. At the Colliers International Conference in Miami, members of the land advisory board were hot on land acquisition. They cited everything from states like New York and New Jersey with rising population demographics as targets for buying. Areas where international trade rule are hot and even bankrupted partially developed tracts will appear to the right investor who can work within the strictures of a bankruptcy.

As REITs continue to face troubling times with underperforming portfolios, private equity firms will step in, filling the whole left by hedge funds. Capitalized buyers will have opportunities that they have not had in years. Conservative investors, satisfied with 10-20 years of steady returns are on top and it's time that they turn their attention back to owning a piece of earth.


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October 7, 2008

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