As the credit crisis started to unfold, one of the first things we really noticed was the AIG bailout. What I didn’t understand was what sort of exposure AIG had to the credit crisis; I didn’t realize that they had written insurance for the “CMO”s (Collateralized Mortgage Obligations, or, toxic debt wrapped in Christmas paper) and that as these CMOs crashed, AIG was obligated to pay on the loans.
Recently an insurance agent called and wanted me to switch companies, to another insurance company. The particular company he recommended was one which has been in the news as having some problems. This got me to thinking about insurance companies, and how their business model works.
An insurance company collects payments from customers, betting that they won’t have any claims. They take this money and invest it carefully, and make a return on the premiums. With lots of clients, and accidents being fairly rare if the company manages the risk carefully, the investment returns make lots of money for the insurance company.
What happens when the insurance company’s investments all go in the tank, as they are now? How hard is it for an insurer to “cook the books” and show their invested capital at the price they paid for the investment, rather than the current value? What happens when the capital is invested in T-Bills (which are paying near a 0% return now) – how does the company stay in business?
The agent told me that the stock price and profitability of the company does not affect the stability of the company to pay claims. I’m not so sure. The stock price reflects the confidence the public (and institutions!) have in the business; the profitability affects the stock price. If a company is not profitable for an extended period, they will not survive. This would seem to me to affect their ability to pay claims.
I remain unconvinced that the people running and rating these companies may not know what problems they really face. It has been reported that the leaders of some of the institutions that were taken over by the Fed had just previously stated that their institution was in fine shape! They don’t know that their own house is on fire, possibly because of the depth and intricacies of the web spun to make all the debt smell good. So even if an institution is well rated, in my opinion, if the stock price has crashed (I don’t mean cut in half, more like it is into the pennies), and especially if the government has bailed them out, then I would be very careful about using them as my insurance company. Make your own decision.
In the interesting financial times we face, assumptions we have always made are coming unraveled. One example is that the cash value of a money market account fell below $1 – an account that was supposed to be completely safe, just cash in the bank, lost value last year. I don’t think that has ever happened before.
The times we are in now are different from the great depression. Then, there was not much home ownership. Until recently, most families’ biggest and most important investment was in their home. Now, with home prices continuing to fall and unemployment rising, we have similar conditions to the great depression, plus we have a loss of 401K equity and home equity. I fully expect this depression to be far worse than the great depression. Many of our assumptions, things we have known to be true for many years, are proving to be wrong, and many more will be.
It is time to look closely at those things that are the most important to us and be sure we really understand what is happening.
-----
I wrote this last week, before we saw Citibank shares fall below a dollar, and before we heard that the FDIC might be insolvent. For more than a year I have been saying that, if you have more than $100,000 cash be sure it is in separately named accounts (the limit since was raised to $250,000). However now it seems like even that isn’t good enough to protect your assets.
A good friend of mine who is a financial advisor keeps most of his clients’ money offshore someplace in a small, safe bank that does not make loans. (I don’t know the details of this arrangement, but I’m sure there are fees involved). He told me about this about a year ago, and I though wow- that’s excessive! Turns out he was not far off. Of course he has been just about right on most everything he has told me.
While sitting in cash might be attractive, and it might make you feel safe, it might not be so safe – I expect that if you have $10,000 in one bank you will be fine. But people with substantial cash hoards will want to evaluate just where their funds are kept and maybe even convert some into gold or silver and bury it in the back yard! I’m not usually an extreme sort of person, but this economy has me a little worried. Other than 401K, IRAs, and other retirement vessels, I think most Americans have little exposure to the stock markets. So the event of a market crash has little immediate effect on them.
It is the economy downturn which affects everyone. I am a part owner in a small restaurant in Phoenix, and I have watched the business go from fair, to bad, to worse, as the economy turns down. Many talented people are on the street looking for work, and taking whatever they can get. And, as a real estate agent I have seen my business drop off significantly since about July.
It is these sorts of events which will affect everyone. When the credit crisis started, credit dried up. This stopped investors, slowed growth. As a result the economy slowed. As the crisis deepened, psychology started to play a role – investors will wait and see rather than spend money to develop something. Many investors were hurt because most commercial real estate and development loans are short term – if a project takes too long, you have to refinance. And even established projects require refinancing. But no financing was available.
This monster feeds on itself – now no one even wants any credit – investor cash is on the sidelines waiting to see what happens. It is self-fulfilling.
When will we know it is at a bottom? Sir John Templeton said that market tops come when people are irrationally exuberant, and market bottoms occur when there is the greatest distress and fear. We aren’t there yet, I don’t think. Most likely the first thing we will see is an upturn in the stock markets; the market almost always presages the economy. Market crash, economic crash. Market rally, economic rally. The thing is, we could see some big rallies in the days ahead which are bear market rallies and not the start of a bull market. It is interesting that one segment doing well right now is firearms manufacturing. As long as this keeps up I think it is a bearish sign.
So my whole point here is that you should be very careful with your cash. I note that Scottrade, the brokerage I use for most of my trading, is insured by SPIC and further insured by Lloyds of London (which appears to be in trouble, about to be partially nationalized). I don’t know how solvent SIPC is, and I am concerned. But not enough to bury gold in the back yard (yet)!
-PLH
PS My brother sent me this link showing Ron Paul talking about this mess. One of the few voices of reason, in my opinion.
And here is a link to a [THREE HOUR] video talking about how banks work. It is worth every single minute and I highly recommend you watch it. It is a HUGE eye opener.
Saturday, March 7, 2009
Monday, March 2, 2009
Commercial Landlord Foxtrot
This is a time for calm. The Foxtrot, in ballroom parlance, is a “smooth” dance, noted for its elegance and artistry. Here are some reflections on how thoughtful landlords might think and proceed gracefully, navigating shoals littered with face-planted brothers and sisters.
One: We’re all in this together. There are no tactics that will guaranty successful commercial projects in uncertain financial times. But here’s one fundamental: A well-tenanted project not only shows well to new prospects, it flows better, cash-wise. So, a landlord must take a long view toward reducing tenant failures. That’s right—I’m suggesting viewing your tenants as your co-conspirators opposing your creditors, instead of seeing your tenants as your enemies. No tenants = no cash flow = no mortgage payment. It’s not a complicated formula. Think constructively, and abandon yanking out the hacksaw to mangle away a partly-functional limb.
Two: Appreciate that tenants are not all alike. Super-regional and national tenants are not motivated the same as “moms and pops” enterprises. Prepare for entirely distinct types of conversations with the principals of the two types of tenants. Larger tenants with multiple units (offices/stores) make decisions based on market forces that often have little to do with your particular project or its productivity there. Consider bank branches, or electronics stores—they may be doing well in your center but still tank. So if your multi-unit tenant is thinking of closing fewer than all its locations, ponder this: what will cause them to stay open in your project?
Three: If your center is financed, read your loan documents carefully, especially the loan agreement, the deed of trust and, if separate, the assignment of rents. Look for rays of hope that you may be able to renegotiate rent terms without having the lender interject its point of view; in these times, lenders may not be making profoundly wise decisions. The institutional lenders, they say, have their own sets of issues. Often, for example, the loan documents say that “major” tenants’ leases cannot be modified without lender consent. Look especially for text that states or implies that the landlord has some latitude in acting in the “ordinary course of business.” There is no ordinary course of business in market crises; therefore, this may afford you some latitude to act in concert with saving your project notwithstanding express prohibitions on your conduct.
Four: Be patient--and listen carefully. You’re not the only creditor of your tenant, who is battling with vendors, suppliers, equipment lessors, lenders and perhaps the landlords of its other location[s]. A tenant who is struggling for survival may have some good ideas, scattered among its unrealistic ones, about how to stay in business in your project. Consider adopting the tenant’s sensible proposals into your relationship.
Five: Be creative. Consider some of the following options in workouts with tenants:
a. Relocate them in your project; this can be a win-all-around situation, if the result is that you keep your tenant and a portion of the original rent payment and common area contributions, perhaps freeing up a prime location for re-letting in the process.
b. Back-load a portion of the reserved, fixed rent in a lease amendment; yes, this will diminish your cash flow in the short term—but so does a half-empty project.
c. Allow the tenant to sublease, so long as that rent flows directly to the landlord and the sublessee agrees that any option to renew has to be approved by you.
d. Allow them to downsize, if loss of customers has translated into decreased inventory or staff or whatever it is that has shrunk its need for space; of course, you cannot accommodate a request to reduce the rentable square footage if the shrinkage means that the usable footage excess is compromised by bizarre (unusable) configurations of floor area. You must see the whole chess board at once.
e. Apply a portion of the security deposit to rent installments due—I mean, do they really have time to trash their suite if the tenants are trying to make ends meet? You always can demand replenishment of the deposit when times are better.
f. Promote the businesses by permitting a sidewalk sale (if retail) or [-gasp-] putting the name of the tenant in an otherwise-still empty sign bin in your project monument. One of my clients negotiated a billboard lease renewal by exacting from the lessee a promise that his office project tenants on site could have a discount on advertising when the billboard had no other business.
g. Consider accepting surrender of the premises and terminating the lease before the tenant files bankruptcy and your space becomes subject to the 120- day, assume or reject period in the Code. “Go ahead and file—I dare you!” may not be your smartest mantra—try, instead, asking for evidence of insolvency in the course of making your decision whether to take a hard line as opposed to abating some of the rent for a period or just terminating the lease altogether.
h. Accept rent more frequently than monthly; your loan documents may say you won’t accept rent more than a month in advance—but there are no other handcuffs on when you accept it, usually. With competing mouths to feed, might it be more likely you’ll get paid if you accept half the rent two times during the month?
Six: Scrutinize your common area expenses. Green-eyeshade your CAM vendors’ billings, and make sure their services are re-bid at the end of every contract period. There are plenty of people who would like to mow the turf in the common area or wash your windows these days. Minimize expense by cutting back service; what about having janitorial service only 4 days a week? Think your tenants will despise you for cutting their pass-through costs by 20%? And hey, what’s your management company charging you? By being thoughtful and demanding competitiveness from your vendors, you’ve saved everyone money, including the tenants.
Seven: Continue to study the tenant market. Read widely in the field of your leasing product-type. What’s the forthcoming demand for your type of project, and how can you start soliciting that business now? How do you best position your project for occupancy (besides terminating your tenancies to the “see-through” building point)? Take a really smart commercial broker to lunch; ask her what innovations she’s seeing in your market that is making leasing happen? Remember the adage “the harder you work, the luckier you get.”
Eight: Those you befriend in adversity remain your allies in prosperity. I’m cynical enough not to believe this in the abstract. But I’ve seen it occur in business life, so I know it can happen—“it,” here, meaning referral of tenant prospects from existing or former tenants.
So, landlord--are you doing the dance of Saint Vitus, or trotting with the Foxes?
MNW
One: We’re all in this together. There are no tactics that will guaranty successful commercial projects in uncertain financial times. But here’s one fundamental: A well-tenanted project not only shows well to new prospects, it flows better, cash-wise. So, a landlord must take a long view toward reducing tenant failures. That’s right—I’m suggesting viewing your tenants as your co-conspirators opposing your creditors, instead of seeing your tenants as your enemies. No tenants = no cash flow = no mortgage payment. It’s not a complicated formula. Think constructively, and abandon yanking out the hacksaw to mangle away a partly-functional limb.
Two: Appreciate that tenants are not all alike. Super-regional and national tenants are not motivated the same as “moms and pops” enterprises. Prepare for entirely distinct types of conversations with the principals of the two types of tenants. Larger tenants with multiple units (offices/stores) make decisions based on market forces that often have little to do with your particular project or its productivity there. Consider bank branches, or electronics stores—they may be doing well in your center but still tank. So if your multi-unit tenant is thinking of closing fewer than all its locations, ponder this: what will cause them to stay open in your project?
Three: If your center is financed, read your loan documents carefully, especially the loan agreement, the deed of trust and, if separate, the assignment of rents. Look for rays of hope that you may be able to renegotiate rent terms without having the lender interject its point of view; in these times, lenders may not be making profoundly wise decisions. The institutional lenders, they say, have their own sets of issues. Often, for example, the loan documents say that “major” tenants’ leases cannot be modified without lender consent. Look especially for text that states or implies that the landlord has some latitude in acting in the “ordinary course of business.” There is no ordinary course of business in market crises; therefore, this may afford you some latitude to act in concert with saving your project notwithstanding express prohibitions on your conduct.
Four: Be patient--and listen carefully. You’re not the only creditor of your tenant, who is battling with vendors, suppliers, equipment lessors, lenders and perhaps the landlords of its other location[s]. A tenant who is struggling for survival may have some good ideas, scattered among its unrealistic ones, about how to stay in business in your project. Consider adopting the tenant’s sensible proposals into your relationship.
Five: Be creative. Consider some of the following options in workouts with tenants:
a. Relocate them in your project; this can be a win-all-around situation, if the result is that you keep your tenant and a portion of the original rent payment and common area contributions, perhaps freeing up a prime location for re-letting in the process.
b. Back-load a portion of the reserved, fixed rent in a lease amendment; yes, this will diminish your cash flow in the short term—but so does a half-empty project.
c. Allow the tenant to sublease, so long as that rent flows directly to the landlord and the sublessee agrees that any option to renew has to be approved by you.
d. Allow them to downsize, if loss of customers has translated into decreased inventory or staff or whatever it is that has shrunk its need for space; of course, you cannot accommodate a request to reduce the rentable square footage if the shrinkage means that the usable footage excess is compromised by bizarre (unusable) configurations of floor area. You must see the whole chess board at once.
e. Apply a portion of the security deposit to rent installments due—I mean, do they really have time to trash their suite if the tenants are trying to make ends meet? You always can demand replenishment of the deposit when times are better.
f. Promote the businesses by permitting a sidewalk sale (if retail) or [-gasp-] putting the name of the tenant in an otherwise-still empty sign bin in your project monument. One of my clients negotiated a billboard lease renewal by exacting from the lessee a promise that his office project tenants on site could have a discount on advertising when the billboard had no other business.
g. Consider accepting surrender of the premises and terminating the lease before the tenant files bankruptcy and your space becomes subject to the 120- day, assume or reject period in the Code. “Go ahead and file—I dare you!” may not be your smartest mantra—try, instead, asking for evidence of insolvency in the course of making your decision whether to take a hard line as opposed to abating some of the rent for a period or just terminating the lease altogether.
h. Accept rent more frequently than monthly; your loan documents may say you won’t accept rent more than a month in advance—but there are no other handcuffs on when you accept it, usually. With competing mouths to feed, might it be more likely you’ll get paid if you accept half the rent two times during the month?
Six: Scrutinize your common area expenses. Green-eyeshade your CAM vendors’ billings, and make sure their services are re-bid at the end of every contract period. There are plenty of people who would like to mow the turf in the common area or wash your windows these days. Minimize expense by cutting back service; what about having janitorial service only 4 days a week? Think your tenants will despise you for cutting their pass-through costs by 20%? And hey, what’s your management company charging you? By being thoughtful and demanding competitiveness from your vendors, you’ve saved everyone money, including the tenants.
Seven: Continue to study the tenant market. Read widely in the field of your leasing product-type. What’s the forthcoming demand for your type of project, and how can you start soliciting that business now? How do you best position your project for occupancy (besides terminating your tenancies to the “see-through” building point)? Take a really smart commercial broker to lunch; ask her what innovations she’s seeing in your market that is making leasing happen? Remember the adage “the harder you work, the luckier you get.”
Eight: Those you befriend in adversity remain your allies in prosperity. I’m cynical enough not to believe this in the abstract. But I’ve seen it occur in business life, so I know it can happen—“it,” here, meaning referral of tenant prospects from existing or former tenants.
So, landlord--are you doing the dance of Saint Vitus, or trotting with the Foxes?
MNW
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