Third quarter earnings coming in above expectations, financial's still up from January levels. Some investment banks with all time high earnings but what is going on with real estate? The problem is that real estate doesn't work like other industries. As a matter of fact it is somewhat counter cyclical to the earnings growth cycles of corporate America. As growth accelerates real estate becomes more in demand and since the supply curve for real estate takes years to adjust (concept to construction completion is typically 5 yrs or more) there is always a lag in supply which creates profits in commercial real estate. Problem is that when the economy changes and demand drop quickly but supply reacts very slowly (look out your window I bet you still see cranes moving out there).
On top of this supply demand misalignment that will last many years to come. Real estate also has the problem of the inflated market due to external circumstances that started deflating quickly last year and will likely remain in deflation mode until all the mess is cleared up between bankers and developers. In the past 5 years the availability of capital has been a tremendous booster to property values. Essentially every real estate owner had a willing buyer for his real estate (a lender) that was paying great prices and had no negative tax implications. Example - developer owns apartment building with $100,000 of rent and lender would underwrite this to $65,000 in annual net income divide that by a 6 cap rate produces a value of $1.08M which the lender would give 80% of as a non-recourse loan netting $866,000 tax free. The alternative for an owner was to sell to someone paying a little less than what the bank valued the property for but after tax consequences the net to the owner was less on a sale then on a refinance. So what did every developer do? They financed as many dollars as they could from the property and looked at it as if they had sold the property. So in essence all the capital available through investment banks as securitzed lending created an artificial supply of buyers. When my company was trying to buy properties the past few years are biggest competition was not other buyers it was lenders knocking on doors and providing more net funds to an owner than we as a buyer were offering.
Well as everyone knows that demand disappeared very quickly in 08 and real estate values are reflecting that now and will be for some time to come. As I hope my example illustrates the economy as it sits right now has no real effect on real estate values and won't for years to come. So how does a real estate company survive in a market like this? Fortunately real estate unlike the stock market is not repriced every day so unless there is a major need for a valuation ( refinance or sale ) today's value doesn't matter much and the key is performance. As a real estate operator today's value is created in running the property as profitably as possible. At Signature Community we have had a single focus mindset on doing just that. Running apartment properties to maximize their operating cash flows. And the results are showing with properties running at higher occupancies than competing properties and working under a lower cost structure than the competition we maximize value in '09 and beyond.
Until Wall Street or China or some other provider of liquidity creates a new source of demand for real estate we will be stuck with lower property values so the only way to survive in 2010 let alone strive is to keep operations strong and profitable.
Thanks for making it happen at Signature.
Nick
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