Things happen so quickly, people become mere blurs
Several months back, my for-profit US company launched a workout group, to aid entities – typically large institutions – that find themselves having to take a much more active role in risk mitigation than they had heretofore expected. In that context, I’ve started writing a monthly column, The State of the Market, focusing particularly on issues relevant to multifamily residential and affordable housing – in short, how the bigger picture turmoil affects our industry.
What’s in it?
Nothing illegal, immoral, or fattening, I hope
Here are excerpts from the first three issues:
October: State of the Market 1
Will the capital shakeout hit multifamily?
Shakeout? What shakeout?
How do you know if you have squishy assets? Here are two personal leading indicators I use, after thirty-plus years in the housing business:
1. Poor financial reporting is always a leading indicator of property trouble. I’ve never yet seen a situation where an owner who can’t report – on time, accurately, without extensive journal entries — is in fact doing a good job.
2. Sick owners infect their properties. Ownership and management are tough jobs. Markets are very competitive and react quickly. An owner in trouble in any part of its business tends to obsess about that part, losing interest in other assets, and diverting critical resources to shoring up the weakness and leaving the apartments to fend for themselves.
When properties start to go bad, dropping below breakeven or when the sponsor thinks its equity has disappeared, capital providers become exposed to gigantic agency risk. Covenants, penalties, and incentives that work in a normal market can become useless quickly, once the owner has psychologically given up (which they sometimes do).
We’re giving up defending the property
November: State of the Market 2
To know or not to know?
We’re not worried about the lack of financial reports
As I speculated in a previous State of the Market, the third quarter reporting has been both grim and upsetting, as one after another, large financial institutions – some of them seemingly removed from the subprime mess – reported major writedowns in their structured-finance assets. In some cases, such as Merrill Lynch, the scale dwarfed any previous estimate, including those made only a few weeks earlier. Can such enormous banks or insurers really lose billions that quickly? Who else might have an undisclosed problem?
As part of his vision of Cool Britannia, Tony Blair’s government built a space-age pedestrian bridge over the Thames to the London Eye. The bridge, a graceful sweep, was built to withstand thousands of people walking on it with no trouble – yet the first time it was used, it started to sway with increasing oscillation. As the oscillations grew worse, people on it panicked and fled, almost in a stampede. (You can see a YouTube video of it here, or at the end of this essay.)
As you hear in the clip, the engineers were astonished:
“This isn’t real; this can’t be happening.”
“It was very disappointing. We were witnessing the bridge performing in a way we hadn’t anticipated.”
“We’d done lots of work trying to understand its behavior. We thought we understood it very well. And here it was doing something entirely unexpected.”
What happened? The bridge was designed for normal foot traffic, each person’s pace and tread unique, a normal distribution of impacts. Yet when confronted with a shock, people adjust their gait, and because most people react similarly, they collectively ‘lock in’ – uniformity emerges out of chaos.
Something similar – a reactive credit crunch – is gripping the subprime industry right now. Will it spread?
Is an epidemic contagious?
December: State of the Market 3
Realizing value from structured assets: resell or farm?
What do you do when you’re suddenly worried that a product you bought from a store isn’t the real thing — and all the stores are closed, so you can’t return it?
You thought you were safe buying and selling paper assets easily and securely, based on their labels (ratings) and prices. Unfortunately, turmoil in the credit markets has exposed that labels are unreliable and prices are way too low. Now there is no one to take the goods you don’t want off your hands. What now?
We’re asset managers and we’re here to help you
Even if the market were to resell these assets that have gone into hiding, the assets (and the underlying properties) have significant value. They must be held. Yet structured real estate assets must be worked. Whether the position is debt or equity, a security holder owns a big slice of a property’s Net Operating Income (NOI), and as such, the security holder has an enormous interest in seeing the property’s NOI grow, against that moment when the stores reopen and normal trading can resume. These assets must be farmed, both to grow NOI and to harvest it (collect its cash flow).
If you can’t sell it, you have to farm it. That means paying attention to the underlying asset value, which is way more work than you bargained for.
For that you need an expert in the assets: someone who can tell you what you have, establish its ongoing value to you, grow its value, and help you harvest it when it is ripe.
We’re glad we didn’t sell at the bottom
I’ll publish a new one every month until we return to some semblance of stability, so you should get in the habit of checking.
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