From a small northwestern observatory…

Finance and economics generally focused on real estate

PWC’s Emerging Trends in Real Estate for 2016

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Ever since PWC acquired Peter Korpacz’s excellent quarterly commercial real estate survey, they have really leveraged that theme into a great regular read.  Along with my subscription, their annual Emerging Trends just landed in my in-box, and it’s a really excellent read.  (To access a copy, just click on the link above.)  The report is a must-read for anyone in real estate, particularly in the investment or finance side.  I’ll skip to two of the summaries — one they call “expected best bets” as well as the capital market summary, to give you a flavor of their report.

Expected Best Bets — PWC recommends, “Go to the secondary markets”.  They note that gateway markets have pricing problems, while the “18-hour cities” are “…emerging as great relative value propositions.”  They particularly cite Austin, Portland, Nashville, and Charlotte.

PWC also discusses “middle-income multifamily housing,” and notes the solid business opportunities providing creative answers for what they call the “excluded middle” households.  PWC also encourages planners to re-think parking needs, in light of the changing demands of “live/work/play downtowns.”

On the securities side, PWC notes that many REITs are priced well below net asset value, providing an interesting arbitrage opportunity in 2016.

Capital Markets — PWC opens by noting, “In many ways, it appears that worldwide capital accumulation has rebounded fully from the global financial crisis. The recovery of capital around the globe has been extremely uneven. And the sorting-out process has favored the United States and the real estate industry, affecting prices, yields, and risk management for all participants in the market.”

Whew…. I’m usually loathe to quote so much from another’s work, but I simply could not have said that any better.  PWC quotes one of their survey respondents, a Wall Street investment advisor, who says, “There is going to be a long wayve of continued capital allocation toward our business….”

Survey respondents largely were split on short-term inflation, with about 40% predicting modest increases and 60% looking for stability at current rates.  However, when they look down the road 5 years, 80% of respondents look for modest increases in inflation.  Coupled with that, over 60% of respondents think both short term interest rates and mortgage rates in specific will rise next year, and nearly 80% think such rises will occur over the next 5 years.  Intriguingly, a small but significant minority — about 20%, believe rates will rise substantially over the next 5 years.  Almost no one believes rates will fall, either in the short-term or the long-term.

To sum up the capital markets view, PWC says the general spirit of the industry is positive, albeit with an eye toward risk.  Many are calling for a “long top” to this recovery, but many are also taking defensive postures by shortening investment horizons, paying more attention to the income component of total return rather than the capital appreciation component, and moving down the leverage scale.

As always, I would stress that I am citing a 3rd party source here, and nothing in this review should be construed as investment advise.  That said, PWC’s Emerging Trends is an excellent read, and I highly recommend it.

Have I written about Thomas Bayes yet?

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I had the very real pleasure of speaking at the Appraisal Institute’s annual meeting this past July in Dallas, and indeed I’ve been asked to speak there 3 of the past 4 years — a great group and a very well-done conference.  My topic this year was on “Practical Statistics for Practicing Appraisers”, and given the need for continuing education credit, my talk was scheduled for two hours.  Unfortunately, two hours is either w-a-a-a-a-a-y too much time, or not nearly enough, depending on what you want to do with it.

About the only thing I could do was touch base on a dozen or so different useful topics, talk about the highs and lows of each, and point the audience in the right direction to get more information.  One topic I wish I’d spent more time on was Bayesian Statistics, a little-known and under-appreciated branch of statistical inference which, in fact, has significant every-day impacts on how we analyze (or at least SHOULD analyze) data.  For example, let’s say that I want to determine the house price trend in a particular town, and have no idea what that trend looks like.  I’ll want to construct some sort of “best linear unbiased estimator” (such as a time-series regression) to help me sort all that out.

However, what if afterwards, in that same town, I’ve already measured the overall property trends, but now I’m told that half of the town is known to be contaminated.  Do I still want to use the same estimators, or should my methodology be informed by what is now “prior knowledge” about both the existence of the contamination and the overall price trend in the town?

This use of prior knowledge falls into the category of “Bayesian Statistics”, or “Bayesian Inference”, developed by early-18th century theologian and mathematician Sir Thomas Bayes.  In short, Bayes noted that our inferences could be improved by the existence of prior knowledge.  What’s more, when we’re conducting a Bayesian investigation, our data gathering is anything but random, since we’re seeking data based on our prior knowledge of the situation.  In the contamination matter, I may want to look at price trends for homes in the contaminated neighborhood versus price trends for homes in the non-contaminated neighborhood.  Naturally, I’ll only focus my attention on properties that have actually transacted, which leads to a common problem in this sort of analysis where properties that have not transacted (which may contain different information) are not part of the data set.

Unfortunately, a lot of practical appraisal — particularly in the residential setting — is heuristic, and over-reliance on “prior knowledge” can lead to a level of sloppiness.  That said, a rigorous application of Bayes’ principles, and careful analytical techniques, can allow appraisers to actually develop statistical measures for their valuation work.

Written by johnkilpatrick

August 20, 2015 at 11:26 am

Why I’m not that worried about Greece

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Pundits (and yes, to a degree, I’m one) have taken every position possible over the Greek debt crisis.  I’ll toss in my 2 cents, and hopefully I’ll add a bit to the debate.

First, I’ve never been to Greece, but one of my colleagues from Greenfield just came back and brought me a bottle of Ouzo (than you, U.S. Customs Service).  Also, I had a nice lunch at a Greek restaurant a few days ago.  As economists go, that must count for something.

Here is Greece’s problem in a nutshell — as a stand-alone economy they suck.  Their people are old, the bright young folks go somewhere more productive as soon as they are old enough to read a map, other than feta cheese they don’t export much of anything, and there simply isn’t enough austerity to balance the budget.  Hence, they’ve hocked everything worth hocking right down to the scrap value of the Parthenon to pay for social services and little things like food and medicine.  Additional austerity (demanded from what passes for the right in Europe) will salve the wounds for a while, and additional high living (essentially a non-starter, but none-the-less demanded from the left) simply isn’t in the cards.  The credit cards are maxed out and the repo man is backing up into the driveway.

By the way,  Greece has roughly the same population as Ohio.  Greece’s most important industry is tourism, which accounts for 20% of Greece’s GDP and employs one out of five people who actually have jobs.  In 2014, tourism was an estimated $12 Billion slice of the economy.  However, to put that in perspective, Ohio’s tourism is estimated at $40 Billion per year.  You see?  The most important thing in Greece is about a 4th the size of one of the least important things in Ohio.

We don’t really think about it here in America, but if the 50 states tried to exist as separate nations, some would die on the vine and others would prosper very nicely.  (Although, to be fare, the worst unemployment in America, West Virginia at 7.2%, sits right in the middle between the two healthiest economies in Europe, France and Germany.)   We don’t think about that because of the crucible of the Civil War, which you may have read about in your history books.  Not withstanding some of the news from South Carolina lately, the Civil War was about several things.  Slavery was at the top of the list, for sure, but southern “heritage” types (and yes, I was born and reared in the South) would posit that it was all about states rights versus the central authority of Washington.  Let’s go with that for a minute, just for the sake of argument.  Let’s assume that was the central theme of the war.  How did that turn out?  Huh?  Turns out, the north won.  America was one nation, undivided, period, exclamation point.  Along the way, we’ve made numerous economic decisions which would not be rational if we were 50 separate nations, but make perfectly good sense in the long shadow of the Civil War.  Hence, some states don’t pull their own weight, economically, but we drag them along, sometimes kicking and screaming, as the rest of us march forward into the economic future.

Europe also had a recent crucible.  Indeed, one might think of the 20th Century as one long, amazingly painful period.  It essentially started with the “War to End All Wars”, and then a massively painful depression, followed by, “War, the Sequel”, and then followed by, “Let’s all count down to nuclear Armageddon” as the superpowers stared each other down across Germany’s Fulda Gap.  By the time the Eurozone was created, thinking people in Europe were willing to do whatever it took to unite the continent and make sure that the casus belli of the past no longer existed.

So, that takes us to Greece.  One might not think of Greece as being a focal point, but that would be short-sighted in the extreme.  Of course, anyone who has studied anything about western civilization thinks of Greece as the fountain of democracy.  That said, it is right at the crossroad of Europe and Asia, and has been central to pretty much every argument in that part of the world in the past two or three thousand years.  More to the point, the reasonably solid economies of Europe look at the laggards with pity but also with fear, because a splintering of the Eurozone removes the warm blanket of unity that staves off the kinds of wars that Europe is all too familiar with.

So, like it or not, Europe will hold their noses and cut a check to help pay for Grandma Greece’s hospice bills.  They will probably make her move to from a private room to a semi-private one, and she’ll have to settle for generic medicines from now on, and eat in the cafeteria like all the other folks, but she won’t be allowed to starve, and she’ll get a card every Christmas, as long as anyone remembers the 20th century.

Written by johnkilpatrick

July 10, 2015 at 4:38 pm

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Wow… where was I?

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I have a habit of not mentioning my travels until I get back — it helps to dissuade burglars if they don’t know I’m out of town.

That said, I just returned to the good old US of A from 3 weeks in Spain and France.  I was the lead testifying expert this past Spring in FHFA v. Nomura (more on that eventually), and headed to the land of good wine and cheese for some much needed R&R.  Of course, it’s impossible for me to travel through two of the great countries in Europe and not think about real estate.  Following are some relatively off-hand thoughts about two countries that share a lot of history with the U.S., and considerable high-level political and economic thinking, but surprisingly little else at a granular level.

First stop was Barcelona.  There is a saying in Barcelona — “it’s a great town if your pockets jingle.”  Unfortunately, I have no basis to disagree.  We were in Barcelona for 4 days, mainly touring the great architectural works of Gaudi.  It’s hard not to like Barcelona if you’re able to stay at the beach — and by the way, Barcelona has one of the best beaches in the world.  However, Spain as a whole is suffering 20+% unemployment (remember that during the great depression, U.S. industrial unemployment never really got higher than 35%) and its no surprise that in last months regional elections, the far-left parties captured control from the center-right parties.  Spain is a spectacularly beautiful country, with terrifically friendly people.  However, their government has never really been able to come to grips with the central problem in Europe, which is how to be relevant in a 21st century economic world.  The leftist view sounds good on paper, but there simply aren’t enough industries and raw materials in Spain to nationalize and gain any sort of short-term traction.  (Of course, in the long-term, such nationalization and confiscatory taxation is self-defeating.)

Next, we headed for Toulouse and tour of western France, Normandy, and eventually Paris.  From a purely tourist perspective, one cannot pick a better part of the world to unwind.  I will note, however, that all too many tourists head for “Paris” when they want to go to France.  Don’t get me wrong — I like Paris.  However, all too much of Paris is geared to the tourist trade, and it’s hard to figure out what to do and what not to do.  For example, the Louvre is perhaps the greatest museum in the world, but it’s packed to the gills most days (although I’m told if you are REALLY an art aficionado, head there in January).  On the other hand,  Musee de l’Orangerie right down the road has perhaps the greatest collection of impressionist art in the world (including Monet’s Water Lilies, around which the museum was built).

For a really terrific tour of France, head for the small towns.  We started in Toulouse, which is actually a fairly major city — the 4th largest city in France and the home to Airbus and significant military and space assets.  However, Toulouse was also the capital of the Visigoths in the 5th century and a center of the heretical Christian movement called Caharism in the 12th to 14th centuries.  The architecture and history of the regions is spectacular.  On top of that, the wine and food cannot be beat.

From there, we headed up to the Loire Valley (again, history, architecture, food, and wine) and then headed over to Normandy to tour Mont Saint-Michel Abbey, Omaha and Gold beaches, as well as Point du Hoc.  If you try to duplicate this trip (and I highly encourage it), be sure to wear comfortable walking shoes.  Between Normandy and Paris you hit the town of Giverny and Claude Monet’s home and gardens. Carve out a couple of hours, even if you are not a fan if impressionism, and plan to have lunch (and yes, French wine) in one of the delightful little cafes in town.

France has figured out the trick to monetizing tourism.  They have a massive infrastructure, at a very local level, devoted to attracting, feeding (and yes, watering), and entertaining tourists from all over the world.  The cathedrals, caves, abbeys, castles, and colorful towns are in first-rate order, and every small town in the country is prepped to handle tourists in season.  The bed-and-breakfasts are first-rate, and the amenities meet or exceed anything you would expect in the U.S.  At the worst, a b&b is small and un-air conditioned, but the food and wine will be better than expected.  At best, a b&b will have a room and service to compete with a top-tier U.S. hotel.

Well, enough about that.  More on the more interesting FHFA v Nomura later.  Oh, and by the way — a tip of the hat to Air France.  What a great airline!

Written by johnkilpatrick

June 13, 2015 at 6:05 pm

American Real Estate Society Annual Meetings

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For many years, Greenfield had been privileged to participate in the annual American Real Estate Society meetings, held in late April and typically in a warm, waterfront location.  This year’s meeting was at the Sanibel Harbor Marriott Resort, on the bay near Sanibel Island, Florida.

Of the major academic real estate organizations, ARES has the unique mission of bridging academia and practitioners, and as such draws a large contingent of Ph.D.-types (and others) from organizations like Greenfield.  Somewhat surprisingly for an organization which bridges academia and practice, ARES publishes the largest number of scholarly real estate publications, and has the top-ranked academic journal in the real estate, insurance, and banking fields (the Journal of Real Estate Research, edited by my good friend, Dr. Ko Wang of Johns Hopkins University).

Various researchers at Greenfield authored several papers accepted for presentation at the ARES meetings, including:

  • The Impact of Fracking Sites on Brownfield Funding (Dr. Clifford Lipscomb)
  • Can We Forecast the Next Bubble? (Kilpatrick and Lipscomb)
  • A Primer on Cleaning Residential Real Estate Data (Lipscomb and Dr. Andy Krause of U. Melbourne)
  • Using a Random Forest Process in an Automated Valuation Model (Lipscomb, Kilpatrick, Jessica Kenyon of Greenfield and Dan Tetrick of Greenfield)
  • The Impact of the NAREIT Light Awards on REIT Performance (Kilpatrick and Lipscomb)

Additionally, I had the pleasure of serving as co-chair (with the esteemed Dr. Stephen Roulac of U. Ulster and Roulac Global Research) for one of the sessions where doctoral students presented their research.  Dr. Roulac and I heard presentations from students from Yale, from Royal Agricultural University and U. Aberdeen in the U.K, and U. Regensburg in Germany.

I’ll conclude with a big “shout-out” to Dr. Arthur Schwartz, who despite having been retired for quite a few years, serves as the volunteer Meeting Planner for ARES (at no small personal expense) and manages to secure world-class warm-water resorts for these spectacular meetings.  Sadly, he is taking a sabbatical for 2016, and the meeting will be in chilly Denver.  However, I’m pleased that the meeting will return to San Diego in April, 2017, and to Estero, Fl (near Ft. Myers) in 2018.

Written by johnkilpatrick

May 8, 2015 at 11:54 am

21st Century Valuation Problems

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Did everyone have a great holiday?  It’s been nearly 3 months since I’ve darkened the door of this blog.  Between the holiday season, a couple of very interesting conferences (more on those later) and heading for warmer climates for the winter (MUCH more on that later!), I’ve been terrifically distracted since November.

The trigger to get me off my duff and writing again was a complex Federal Court trial in Missouri last week.  Yes, I was the testifying expert, and yes, my clients prevailed, but that’s not exactly the point.  The point is WHY I was testifying and WHY my clients ultimately prevailed, at least in my humble observation.  The case was a class action concerning the value of a fiber optic telecommunications transmission easement. For a variety of reasons, this case only concerned 789 miles of the easement crossing about 3,250 properties, but the very important lessons learned from this case apply broadly to a variety of modern-day corridor easements.

Earlier in the litigation, the class action had been certified and the Court had held that the responsible party did not have the right to enjoy the easement without compensating the property owners.  The court had held that the defendants had unjustly enriched themselves, and so this trial was narrowly focused on compensation.  That compensation, it was held, would be the fair market value of the easement, and that’s where Greenfield came in.

The defendants proffered a valuation theory called “across the fence”, or “ATF” for short.  ATF models were developed many years ago for easements like railroads and power lines when data on such easements were difficult to come by, and when the change in highest-and-best-use of the property resulting from the easement was minimal, at best.  The ATF theory basically says that the value of the easement is equal to the value of the land taken (usually farmland or forests) plus an “enhancement factor” to equate the more valuable use of the railroad or power line easement.   This enhancement factor would range from 1X for an easement which was no more valuable than the surrounding land to 10X or more for a very valuable easement.  Note that the enhancement factor can be a matter of judgment on the part of the appraiser.  It is supposed to be determined by looking at sales or leases similar easements and similar surrounding properties, but with a dearth of data, the enhancement factor was often just a matter of conjecture.

In addition, ATF valuation required individualized “before-and-after” appraisals of every affected property.  In testimony in Missouri last week, the defendants’ appraiser acknowledged that each “before-and-after” appraisal would cost about $10,000, more or less.  Given that there are 3,250 properties affected by this one easement, that translates into $32.5 million in appraisal fees.  Ahem…..

In addition, the defendants’ appraiser applied a fractional enhancement factor, which he basically simply made up with no data or analysis to support it.  He said that the land devoted to a fiber optic cable telecommunications easement was worth 25% of the value of surrounding pasture and grazing land.  Again, ahem….

Greenfield was called in because modern valuation problems call for modern solutions.  In 2002, the U.S. Fish and Wildlife Service (“FWS”) was faced with the challenge of determining the fair market value of fiber optic cable easements in National Marine Sanctuaries.  Specifically, there were two such easements in the Olympic Marine Sanctuary in Washington State (one each headed to Japan and Alaska) and one in New England.  Faced with the likelihood that Federal land would be used for such easements in the future, and the mandate that private users of public property pay fair market value for such uses, the U.S. Government undertook an extensive review of payments for similar easements, and found that prices ranged from $40,000 per mile to $100,000 per mile.  (In the Missouri case, the defendants’ appraiser, applying pastureland values, a fractional enhancement factor, and a number of other adjustments, arrived at a value of $3.44 per mile.  Ahem, yet again…..)

Shortly after the FWS report, Greenfield undertook our own analysis of telecommunications corridor easement transactions across the U.S.  We gathered over 1,000 transactions dating back to the early 1970’s, with a particular focus on easements where both the grantor and grantee were operating on a level playing field (i.e. — telecom companies versus railroads).  Our findings were solidly supported.  Telecommunications easements are typically valued in America using corridor theory models.  The values of the easements are unrelated to the values of the surrounding land (thus relegating ATF models to the history books).  Corridor easements should (and indeed must) be valued with simple per-foot or per-mile data in a straightforward, easily understood, 21st century model.

The jury in Missouri deliberated about as long as it took to pick a fore-person to affirm the efficacy of corridor valuation models.  The evidence and testimony could not have been more starkly different from the two sides.

The downside?  I would love to have had a piece of that $32.5 million project they proposed.

Written by johnkilpatrick

February 10, 2015 at 7:19 am

REITWorld 2014

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REITWorld is the principal annual meeting of the National Association of Real Estate Investment Trusts (NAREIT), held this past week in Atlanta.  I had the privilege of representing Greenfield, meeting with many of the top leaders in the securitized real estate field. The tone was generally upbeat, not surprising given the great run that REITs have enjoyed the past few years.

The gathering was a mix of very specific information on individual REITs, provided in small group briefings by the leaders of those REITs, along with several large group meetings with briefings on the industry as a whole.  As expected, many of the service providers to the REIT industry were there, such as the research firm SNL Financial, with whom I had several great meetings.

The biggest concern in the meeting was matching past performance.  REIT investors have enjoyed unprecedented gains since the trough of the recession, and even though most sectors of the market look stable and solid going forward, no one believes that returns for the next few years will equal those of the past few years.

Leading economists presented two of the five featured programs — Jeffrey Rosensweig, Director of the Global Perspectives Program at Emory U., and Robert Zoellick, currently a Senior Fellow at Harvard’s Kennedy School and former President of the World Bank.  In addition, the Board of Governors dinner speaker was former Secretary of State Madeleine Albright.  The focus and attention of REIT leaders is clearly on the global scene.

In other news, the death notices for traditional retail may be premature.  As noted by Sandeep Mathrani, CEO of General Growth Properties,  malls today can really be divided between “A” and “B” properties. The “A” properties are in high demand by in-line tenants, who have much stronger balance sheets than in the past.  Right now, occupancies in the high-90% range with strong rent growth is the norm for “A” retail properties.  As such, this sector is looking for continued strong growth in the near term.

Europe is projected to be an interesting market in the intermediate term for REITs looking for global expansion and choice properties.  About 80% of the commercial real estate debt in Europe is scheduled to mature in the next 5 years, and many if not most of the debt holders are in no position to renew or “roll” that debt.  As such, cash-rich investors may have some cherry picking opportunities soon.

Finally, the closing session speaker was Mark Halperin, Managing Editor of Bloomberg Politics.  He shared intimate insights on the Washington political scene for the next few years, with a particular emphasis on the presidential campaign (which, if you didn’t notice, started last Wednesday morning).


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