Commercial Property Herald

Geithner confident that Economy has Stabilized

DSNNEWS.COM quotes Timothy Geithner as saying that the financial system is stabilized in their article, Banks can Handle Commercial Real Estate Losses Geithner Says. Sounds a little like Prime Minister Chamberlain stating that "Peace in our Time," after meeting with Hitler just before Germany attacked Poland to start World War II.

I get it that part of Mr. Geithner's job is to instill confidence in our financial system.  The less confidence, the more instability.  But lets get real.  I just don't see how he can be so confident.  No, I don't think that our banking system will collapse, but I do see many, many more bank failures and while we don't have the RTC taking over banks and Savings & Loans as they did in the 90's, I see us doing the same thing by having the government give money to the big banks so they can survive all of the loan defaults and so that they can buy out the smaller banks.  Can you spell g o v e r n m e n t  s u p p o r t e d  b a n k  c o n s o l i d a t i o n? And by the way, I am paying for all of this along with the bonuses being paid to the bank executives for doing such a great job.

The only thing that I am confident in at this point is that someway, somehow, we or our children are going to have to pay back all that this is costing and the rich will likely get richer and the middle class and the poor will likley get poorer.

Capmark Bankruptcy to be in Better Shape?

Interesting article in Shopping Centers Today Week publication of October 30, 2009, Vol. 14 No. 43.  In that they discuss the possible overall effects of the bankruptcy on the overall market, suggesting that since the bankruptcy is intended to be a restructuring rather than a liquidation, the effect on the overall market is expected to be minimal. What the positive looking analysis overlooks however is that only about 5% of the chapter 11 reorganization bankruptcies make it to plan confirmation. However, those that are well planed before they file their bankruptcy petition have a much greater chance of emerging out of chapter 11 with a confirmed plan.  Capmark is led by a pretty heavy weight group of investors that you would have to believe have the best bankruptcy lawyers available; you would think.

Playing Real Estate Like Blackjack

It seems that some pension managers manage the funds a little like how I play Blackjack; only not as conservatively as I gamble.

Just so you don't get confused and wonder what this posting has to do with real estate; I am using Blackjack as an analogy. I'll be getting to the real estate part shortly after the Blackjack.

My wife and I go to a local indian casino or Las Vegas about 3 times a year, just to get away from the kids and have some private time together.  We are not big gamblers but we do like to play Blackjack together. I usually bring $300.00 - $500.00 that I can afford to lose and which I consider my cost of entertainment, if I lose it all.  However, I can't recall a time that I have lost it all since I usually pull up stakes if I am on a losing streak because I don't like losing.

My basic betting strategy is to bet light when the odds are against me and to put money on the table when the odds are in my favor. When the odds are in your favor, you better put your money on the line to make up for your loses. I swear that when I see the dealer showing a 6 and I have an 11, I start to swoon and can't get my chips on the table fast enough. Understand that I do this with the clear understanding that over the long term, the odds are always in favor of the house.

So, lets use the dealer showing a 6 as an example.  If the dealer is showing a 6, the odds are likely that the dealer has a picture card or a 10 down so the dealer is likely to have a bust hand.  The key word here is "likely", I don't count cards, particularly when the dealer is dealing from a 6 deck shoe.  It doesn't always go according to Hoyle.  As I mentioned earlier, if the dealer is showing a 6 and I have a 5 and a 6 for a total of 11, I am going to double down because it is likely that I will draw a picture card or a 10, end up with 21 and the dealer is likely to bust.  If I have a 5 and 6 and the dealer is showing a picture card, although I see many people double down in this situation betting that they are going to get a picture card, being the conservative gambler that I am, I usually will not double down and be happy just winning my originally bet, if the gambling gods are smiling down at me.

Now comes the fun part. What does my gambling habits have to do with fund managers and real estate investing, you ask? A great deal too much, apparently. This post came to my mind after reading the blog posts, Laying on bets at biggest US pension fund and California pension funds close to bankruptcy.

Apparently, the fund managers over at CALPERS, like probably many other managers, bet big during the real estate run up.  They put their member's money on the table, not only when the dealer was showing a 6, but when the dealer was showing a picture card. And now, it seems like they are continuing to gamble with their member's money even when they have a 10 or 9.

There are some huge differences between how I gamble and the reported investment strategies of some of the fund managers:

• I am gambling with my own money not other peoples money who have put their trust in me;
• I am a conservative gambler and will only put at risk what I can afford to lose.  I have made a conservative risk assessment;
• I gamble for entertainment, not for business

Look, I understand that when managing a pension fund, there is a certain risk to any investment.  The managers are under a fiduciary duty to maximize returns and if they don't, the will be damned for being too conservative. But they are also subject to a fiduciary duty to make a reasonable risk assessment and not put too much of their member's life support at risk and I get the sense that the managers got so caught up in the thrill of gamble and their apparent successes that they began to believe that they were, perhaps a little smarter than their members good.

Where are we heading on the Commercial Real Estate Market

It's now been more than a year that I have been predicting gloom and doom for the commercial real estate market and it is now time for me to update my take on things.  Actually, it has been more than a year since I was predicting that commercial real estate would follow the residential collapse as soon as I began to see signs of the residential collapse in early 07.

I still see a downward trend for at least another year or more.  However, it is clear that the big players, not overloaded in debt or those with available cash or financing are starting to get back into the market and are starting to take advantage of lower prices.  Reuters has an interesting article on the emerging availability of financing, including the availability of alternative methods of financing made possible by the Federal Reserve Lending program, US Commercial Real Estate Lending reemerging - Citi.I am having trouble getting a grip on these new alternative means for cash and what the ultimate effect on the market will be.  However, I do believe that if you are not too debt laden, there is never a bad time to buy real estate in Southern California, just a bad time to sell.

Anecdotally, it seems that evictions are up in my client's shopping centers but there is a surprising amount of leasing activity, so it doesn't look like there has been a total collapse, yet in retail and there appear to be signs of some stabilization.  With that being said, I am hearing stories of tenants unable to commence leases because they cannot get financing for their business or tenant improvements.

All-in-all, while the prognosis still appears to be uncertain, the market now bears closer scrutiny for opportunities, particularly for cash heavy investors, and perhaps in the smaller shopping center properties, left alone by the big players.

Stay tuned for a post that I will be publishing soon on what commercial landlord's should be doing to protect themselves when they offer to advance financing or tenant improvements for incoming tenants.

Can Tenant Waive Landlord Restrictions on use of Security Deposits

In my earlier posting, Commercial Landlord's Obligation to Return Security Deposits addressed the restrictive nature of California Civil Code Section 1950.7, which, generally limits the landlord's ability to use a commercial tenant's security deposit to up to approximately 2 months rent, when the default is the payment of rent.  If you are holding more in the hope of using the balance to pay future rents, forget it, unless, your lease explicitly has the tenant waive the provisions of California Civil Code Section 1950.7, a provision that I don't see in leases often.  Yes children, your first line of defense here, if you are a commercial landlord is to have a provision in the lease, explicitly waiving the landlord's restrictions. It should be noted that the "Standard," American Industrial Real Estate Association lease does not include such a waiver.

Let's go over a practical example, with and without an explicit waiver:

With Waiver:  Landlord is not sure about the tenant's financial ability to pay rent so it requires as part of the lease, a security deposit equal to 6 months rent and CAM charges, which the tenant pays.  13 months into the lease, the tenant stops paying rent and is 2 months in arrears by the time they abandon the premises and terminate the lease.  Assume for the moment that the lease has been terminated, an issue that I will discuss later in more detail.  Landlord may immediately sue for future rents, assuming the lease already allows the landlord to do so and can apply all of the security deposit to the balance of rents owing, both in arrears and prospectively.

Without Waiver: Considering the above facts and if the lease does not provide a waiver of California Civil Code Section 1950.7, the landlord must return 4 of the six months security deposit withing 30 days after the termination of the lease, even though, both the landlord and tenant know that the landlord will ultimately be owed an amount equal to or greater than the 4 months security deposit that has to be returned.

In a strong economy, this issue may not arise that often since the leased premises are often re-leased relatively quickly and a large security deposit usually does not need to be drawn down upon and large security deposits are not as common.  In a weakened economy it becomes a more significant issue since larger security deposits are more common and the need to draw upon the security deposits increases as vacancy rates increase.

There are some alternative remedies, some of which I favor and some, which I do not, all of which will be addressed in later posts.  However, from the landlord's perspective the waiver of California Civil Code Section 1950.7, is clearly the least expensive and most favorable security deposit remedy that the landlord has in its arsenal against defaulting tenants.

Howard Kline will be Speaking at RIAOC Orange County, April 21, 2009

I will be speaking at the Realty Investment Association of California (RIAOC) on Tuesday morning, April 21, 2009. At the Garden Grove Elk’s Lodge. The address is 11551 Trask Avenue, at the corner of Newhope.

I will be speaking on Hot Topics relevant to commercial brokers and property managers in a down economy, which I expect to worsen over the next year, that is the economy, not my speaking. A little sneak peak on the topics that I have chosen will include:

1. Subordination, Attornment and Non-Disturbance Agreement in leases - Now becoming more relevant to tenants in an age for commercial foreclosures
2. Guarantor liability on commercial loans, even in the event of non-judicial foreclosures. We see more of them then in the 90's due to the prevalence of property being held in LLC's.
3. Negotiating requirements of some deep pocket and/or recession proof retail tenants.
4. Effect of Landlord Bankruptcy

Retail Hit List

In what I would admit to overstating the obvious, I am providing my updated retail hit list of categories of retail business to be concerned about rent payments, evictions abandonment and overall survival over the next twelve months.  This list is not intended to be all inclusive but just the ones high on my list that I either seem to be dealing with a lot or expect to be:

1. Anything furniture related, both residential and commercial.  Anything surviving the next twelve months are likely to be in a good position after the shakeout. However, if experience serves me correctly, during the downturn of the early 90's, I was constantly evicting furniture tenants or representing landlords whose furniture tenants filed bankruptcy, constantly held going out of business sales and whose inventory mysteriously disappeared.
2. High End Restaurants
3. Electronics retailers.  Best Buy looks pretty good right now as long as it is not over leveraged and it can continue to provide a good shopper experience versus the internet and the big box stores such as the Walmarts and Costco's.
4. Tutoring and pre-schools
5. Specialty exercise like Curves;
6. Anything automobile except automated car washes and gas stations.  I am not sure about parts stores although my sense is that they should be doing alright.
7. Anything over leveraged.  Be wary of any tenant that needs to or within the last two years has spent a great deal of money on tenant improvements.
8. Jewelry and precious stones
9. Yogurt, at least in Orange County, California.  Actually, there is nothing wrong with this model, generally, it just seems way overbuilt and far to competitive in South Orange County.

Simon Property Group Seems to be doing Well

Going against the grain or not yet feeling the pain, Simon Property Group, major national owner of major malls, including Laguna Hills and Mission Viejo Malls in Orange County California, reports strong 4th quarter, 2008 funds from operations. The credit the good news from strong cost cutting measures over the last year, but admit that the retail environment has been difficult and they expect it to remain that way for at least this year.  With that being said, they expect their Premium Outlet NOI to increase by 5% over the next year. 

In a related note, based upon a recent IRS ruling allowing REITS to pay out a portion of their dividends in stock, Simon has reported that it will pay out 90% of its 4th quarter dividend in this fashion, thus preserving a huge amount of cash.  So this is where they are getting their "funds."  Wonder what the "stock-in-lieu," is being valued at?  Just for those of you who aren't aware, REITs or otherwise known, longhand as Real Estate Investment Trusts, are public companies that are required by law to pay out 90% or their income as dividends. This works ok in good economic times but may be pretty tough to handle in tough times like now, certainly limiting a REITs opportunities to preserve cash to survive an economic downturn.  By distributing their income as stock, they get to hold onto a lot of cash.  This could be a very smart strategy.

Sounds like they have been anticipating the war and they have been building the war chest to do battle over the next year or so. 

Keep in mind that the above report shows an increase in available cash, not revenues, which I would expect to drop over the next 6-12 months.

Retailers to Get Smart?

Ok, let me get this straight, the recession/depression is forcing retailers to rethink their business operations and may force them to operate with a lot more thought.  Now, this is a bad thing?

A recent article on MSNBC, Retailers Prepare for a New, Frugal Future, describes how the tightening economy is causing some retailers to reduce their inventory, cut out marginal suppliers, holding special events and otherwise making greater effort to gauge customer interests and satisfaction.  So, some retailers are actually going to consider running their businesses lean, mean and smart.  This is not a bad thing and is not a good thing, just because stores will be less cluttered.  Besides, if I need or want something that is not in a store, I can always find and get it online.

I think it is a great thing that I can expect some business to react to the economic downturn as an opportunity to rethink their business and operations models and try to improve.  These are the businesses that are most likely to survive our tough economic times and come out a better business. This is what we need to do as a country, businesses, families and individuals.

I can tell you that over the last 6 months, like many other American families, my family and I have been tightening our belts and looking into many expenses that we just don't need to incur.  The truth is, we probably never needed to incur many of those expenses.  Client's need me more than ever, but don't pay as quick or not at all, lines of credit have shrunk or are no longer available and I have had to rethink whether or not I really need to have my credit cards charged automatically, every month for things that I never do or use.  And please, don't tell me that I am going to help pull the country out of a recession by spending money on things I don't need.

If retailers have to get smart in order to survive, that is a good thing for us all and we should all follow suit.  I hope that our President Obama and Congress does the same.  Making adjustments and learning to be smart, sometimes causes discomfort and pain, but if you can stay the course, you almost always become better.

Borders & Waldenbooks Closing Store in Sacramento

Although I live in Southern California, I just received an email advertisement from Borders announcing the closing of a store in Sacramento.  Now this closing could just be a natural evolution of the termination of a lease, the possible re-opening of another location in Sacramento or another number of other reasons, totally unrelated to the economy.  However, I have been so primed to expect store closings as a result of the economy, I wouldn't at all be surprised that this closing has quite a lot to do with the weakening economy.  My family, including my three children, 9 - 14, over the last 6 months have been visiting the public library and getting our reading material there, rather than buying books at our local Borders.  I suspect that my family is not the only one taking this cost cutting measure, which, likely is having an effect upon Borders revenues and may cause further closings.

Rather than re-writing this post to better explain my last sentence, it thought it would be better stated, just to clarify that I am not predicting that Borders will be closing more stores because my family wasn't buying as many books from Borders, (we still buy books there and enjoy the store), but that Borders is likely feeling the economic pinch, pretty seriously as others use their public libraries more.