The Four Clients, Which Are You?

In the book, Why I Left Goldman Sachs, the author Greg Smith describes himself as a “not very religious Jew” but that he appreciates the traditions around the Jewish holidays especially the Passover Seder.  He particularly likes the part of the story discussing the reaction of the Four Sons to Passover: one who is wise, one who is wicked, one who is simple, and one who doesn’t know what questions to ask.  He then goes on to say that just as in ancient Egypt it was told about the Four Sons, so too on Wall Street there are the Four Clients.

And I believe just as there are Four Clients on Wall Street, there are also Four Clients in commercial real estate.  These Four Clients represent universal truth.  By that I mean it’s as true today as it was 3,000 years ago and as true as it will be 3,000 years from now.  And these Four Clients transcend all cultures that have ever existed or will ever exist. 

About half my blog readers are clients and the other half are commercial real estate professionals.  So after each client description I give my suggested response of how the commercial real estate professional can best serve this particular type of client. 

THE WISE CLIENT

These are the ones we hope to always have as clients and fortunately many of my clients fall into this category.  They have excellent commercial real estate experience.  They know the ropes but they also respect what you bring to the table.  They realize you are an important cog in the wheel and they don’t grumble about the fee you earn. 

OUR RESPONSE: Treat them with the respect that they deserve.  Listen to them because you have the opportunity to learn from them.  Bend over backwards to get the deal done as promised.

THE WICKED CLIENT

The Wicked Client knowingly withholds adverse information from you about the property or about himself in order to get the best possible outcome for himself.  He has no problem  cutting ethical corners if that is what it takes.  He hopes that whatever he is hiding will stay hidden just long enough to get the deal done. 

OUR RESPONSE: When we find out that important information has been withheld, we disclose it to the light of day.  To not disclose it makes us a party to his deception.  So if it means we lose the transaction and/or the client we do what is necessary so we can go to bed at night with a clear conscience. 

THE SIMPLE CLIENT

The Simple Client thinks he knows more about commercial real estate than he actually does.  He generally has an over inflated ego and as a rule does not trust anyone’s judgment but his own.  If left to his own ways, the outcome of the transaction will get done but it will likely be a more painful process and have a less favorable outcome than if he would have taken your experienced counsel. 

OUR RESPONSE: It is our duty to protect the Simple Client from himself.  We should vigorously give them our best counsel (even when they don't trust us or our advice) but ultimately we leave the decision making to them.  As easty as it would be to be a "yes-man," give them your best counsel and even if they don't take it, they will deep down grudgingly admire that you weren't their sycophant.

THE CLIENT WHO DOESN’T KNOW WHAT QUESTIONS TO ASK

These clients are the most vulnerable, the easiest to take advantage of.  These are the clients that really shouldn’t own commercial real estate.  They don’t even know what questions to ask.  This reminds me of one of my clients, a recent widow whose husband before he died was the one who liked owning and managing commercial real estate.  She was a passive investor but now she had to make all the decisions on her own.

OUR RESPONSE:  Guide them through the process.  Give them wise counsel and charge them a fair fee for services rendered.   One definition of integrity is doing the right thing when no one is looking.  With the vulnerable client we show integrity when we treat them right, especially when they wouldn't realize it if we were taking advantage of them.  

So in ending this article I ask, “Which client are you?”  In reality, most of my clients are a combination of two or more of these traits.  Do an honest self-assessment and once you can honestly admit to yourself who you are then find the commercial real estate advisor who will work best with your personality bent.  If you have a tendency under stress to cut ethical corners find someone who will keep you on the straight and narrow.  If you have a tendency to be a bit blustery don’t hire a “yes-man.”  And if you believe you’re in over your head find the advisor who you believe will always be looking out for your best interest and not his own. 

Is It Time To Break Up The Big Banks?

There is a growing, bi-partisan movement on Capitol Hill to pass legislation to break up the big banks.  When was the last time that Democrats and Republicans worked in a bi-partisan fashion on anything?  But I digress. 

Former Federal Reserve Chairman Alan Greenspan said recently, “if push comes to shove… I would be in favor breaking up the banks.”  Conservative columnist George Will recently wrote a persuasive editorial urging conservatives to support legislation proposed by Ohio U.S. Senator Sherrod Brown (D) to break up the big banks.  Before we look at this proposed legislation, let’s look at the facts.

How many financial institutions are there in the U.S?  As of 2010, there were about 7,700 financial institutions with insured deposits from the Federal Deposit Insurance Corporation (FDIC).   

How are assets distributed among these 7,700 banks?  The top 12 banks currently hold 69 percent of the total assets of the banking industry.  Community banks, which total about 5,500, have about 12 percent of the banking industry’s assets. 

What are the problems associated with large financial institutions?

1. They are too big to fail.  We cannot allow them to fail because of the negative consequences to our economy and to the world’s banking community.  So this means that we socialize the losses (taxpayers pay the bill) but when they are profitable, as they are now, the banks are allowed to keep their full share of the profits.
2.  They are too big to manage and too complex to regulate.    The recent bank scandals – LIBOR manipulation, money laundering, robo-signing, the “London Whale” – prove the megabanks are out of control.  Though there are a lot of good things in Dodd-Frank, it can only do so much to regulate bad behavior in the banking industry.
3. They are given preferential treatment.  The 20 largest banks pay between 50 to 80 basis points less when borrowing from The Federal Reserve than what community banks must pay.  
4. They are too big to prosecute.  Attorney General Holder stated in recent Senate testimony that “some of these institutions are so large that it becomes difficult for us to prosecute them.”  So in essence, they are too big to jail.  To prove this fact, no one all Wall Street was found guilty on any charges stemming from the 2008 financial meltdown.

So what would the SAFE Banking Act, co-authored by Senator Brown and Senator David Vitter (R-La), do to solve these problems?

1. It would provide sensible limits on the amount of debt that a single financial institution could hold.  No bank could have more debt than 2% of U.S. GDP; and no investment bank could have non-deposit liabilities exceeding 3% of GDP. 
2.  Their funding would be required to come from more stable sources, with about $3 of deposits for every $1 in volatile non-deposit funding.  
3. Banks in excess of this limit would be given three years to comply by drawing up their own proposals to meet this requirement.

Which banks would be affected?  Only six banks would be broken up: JP Morgan Chase, Goldman Sachs, Bank of America, Morgan Stanley, Wells Fargo and Citigroup. 

Now that the economy is improving and there are no immediate crises at hand, we need our legislators to push this bill through Congress on a bi-partisan basis for the president’s signature.  This is something that all of us should want to have enacted.  This is good legislation.  Let’s do it!

Sources: Is Fed Signaling Stance on Bank Break-Ups?, by Kayla Tausche, CNBC.com, March 15, 2013; Senator Sherrod Brown explains why he wants to break up the big banks, by Ezra Klein, The Washington Post, March 9, 2013; Time to break up the big banks, by George F. Will, The Washington Post, February 8, 2013.

Are we experiencing a stock market bubble?

The Dow Jones Industrial Average closed today (March 8th) at another record all-time high of 14,397.07. On the surface this seems like great news.  At long last we are emerging from the Great Recession of 2008.  I read an article in today’s Oregonian which stated that with the recent rise in home prices and the robust increases in the stock market that most Americans have regained the net worth they lost five years ago due to the collapse of the economy.  Wouldn’t that be good news if it were true?  It makes me want to sing a round of “Happy Days Are Here Again.”  

The question that is on my mind, and a lot of like minded people is, “Are we experiencing a stock market bubble caused by The Fed’s quantitative easing policy?  Federal Reserve Chairman Ben Bernanke says emphatically “no.”  He recently told the Senate Banking Committee that he "does not see much evidence of an equity bubble." Yes, stocks are high he says, but that’s because The Fed’s recent policies, which have kept interest rates near zero since 2008, are working to spur spending. 

So let’s begin with the facts.  I think there are three possible reasons for the stock market surge:

• First of all the economy is not as weak as we have been led to believe.  We have seen modest growth in autos, housing and manufacturing activity.  Today’s employment report shows improvement in the private sector employment resulting in a downward tick in unemployment to 7.7%.  Not great but improving, nonetheless. 
• With The Fed’s policy of keeping interest rates at near zero is making it impossible to get an honest return on bonds, savings accounts, money market funds or CDs.  I believe investors are putting their money in equities because these other traditional forms of investment have been taken away from them.
• There is some evidence to suggest that investor confidence is surging because we have avoided the serious crises in Europe and the United States from imploding.  The euro zone crisis and the fiscal cliff crisis in the U.S. have worked their way out and investors feel more confident that we will continue to somehow muddle through. 

However when you look at the stock market fundamentals there is little justification for the recent rise in equities:

• Profit growth has been slowing.  The growth rate in the S&P 500 has slowed from 6.0% last year and is projected to be 1.2% the first quarter of this year. 
• The best long-term measure of value is the price-earnings ratio.  Currently the PE ratio is at 22.9 which is 39% above its long term average.  In other words stocks are significantly over priced.  An old rule of thumb is when investors buy assets at above average valuations they will suffer below average future returns.

It is my opinion that this bull market is not driven primarily by economic reality on the ground but by The Fed’s quantitative easing policy.  Fed Chairman Bernanke says that he plans to continue this policy for at least another two years which bodes well for the stock market for the foreseeable future.  In the short run I wouldn’t bet against The Fed Chairman.  But at some point when a new crisis emerges or an old one raises its ugly head then all bets are off.  

Sources: The Great Stock Market Rally, The Huffington Post by Jerry Jasinowski, March 8, 2013; Better than the alternatives, The Economist, March 9, 2013, Bernanke: There is no stock bubble, CNNMoney by Annalyn Kurtz, February 26, 2013.

Sequestration – Will it be as devastating as predicted?

You’ve heard it from both sides of the aisle – Nancy Pelosi, John McCain, President Obama, Mitch McConnell – sequestration will be “devastating.”  “We’ve got to avoid it, we’ve got to stop it,” said John McCain.  He is being universally echoed with similar quotes by all of the Democrat leadership in Congress.  Let’s begin this discussion with the facts. 

What is sequestration?  Sequestration is a budget law that requires across the board spending cuts amounting to $1.2 trillion over 10 years or $109 billion per year.   

How much will be cut in 2013?  The last minute fiscal cliff deal in early January included cuts of $24 billion for 2013, so in the remaining seven months of this fiscal year the government must cut another $85 billion. 

How much is the federal government’s budget for the current fiscal year?  $3.8 trillion

Where would the cuts come from?  Equal amounts would come from the Defense Department and discretionary social spending.  The Defense Department makes up about one-quarter of the total federal budget; discretionary social spending comprises about half of the total budget, and non-discretionary social spending and the interest on the debt making up the balance. 

So who will be most affected by the cuts?  The cuts on a percentage basis would be deepest in defense spending because it represents a quarter of the budget but half of the cuts.

What programs won’t be cut?  Social security, Medicaid, the food stamp program and veteran’s benefits.  Active duty personnel would also be exempt.  Interestingly, Medicare is not exempt.

When does sequestration begin?  Officially it begins March 1^st but in reality it will roll out over a period of several weeks.

So those are the facts.  Now let’s look at what the impact of these cuts in spending will have on our economy.  The Congressional Budget Office predicts that the sequestration cuts will reduce public- and private-sector employment by 750,000 jobs and will reduce our GDP by 0.5%.  In other words, our GDP, which is growing at about 2.0% right now, would slow to about 1.5%.  Depending on who you listen to the list of programs that will be affected is long and deep including:

• the Federal Aviation Administration,
• the National Parks,
• the Pentagon, 
• Health and Human Services, 
• Humanitarian Aid,
• Border Security,
• Education,
• Disaster Relief
• Law Enforcement 

The list appears to be endless.  This is what those in power are saying, in a nutshell, “The world is coming to an end as we know it.”  They may not use these exact words but that is what they are trying to convey.  I respectfully disagree.  Yes there will be consequences to making these cuts.  There will be some pain but the world will go on and in the long run we’ll all be better for it.  

Sadly, there are very few politicians in Washington who are willing to make modest cuts in spending, and make no mistake about it, that is what $1.2 trillion is over 10 years.  A cut of $85 billion in fiscal 2013 represents 2.3% of the total $3.8 trillion federal budget.  Do you actually believe that a 2.3% cut in spending is going to be “devastating?”  Have you had to make cuts in personal spending that have been much greater than this over the past several years?  I certainly have.   

The sequestration cuts are not perfect, they’re a blunt instrument to cut spending, rather than a deliberate plan that sets priorities, trims entitlements, and cuts other spending.  It would be better to replace them with better cuts but the reality is that Washington does not have the will to make spending cuts.  There is no political block in Washington that represents the constituency of the overburdened taxpayer.  In contrast, there are thousands of lobbyists on Capitol Hill that visit our congressional representatives in order to make sure that they’re constituency, whatever that may be, is getting their fair share of the spending pie. 

Don’t buy into the hysteria.  The cuts will not be devastating.  If the sequestration cuts actually happen, six months from now you’ll hardly notice. 

Sources: Sequestration Q & A, Money Watch, by Jill Schlesinger, February 22, 2013; Sequestration: The Facts About the Policy, BeforeItsNews.com, February, 19, 2013; The GOP Divide Over Sequestration (and Everything Else), The Atlantic, by Molly Ball, February 15, 2013.

Three Things to Consider When Choosing a Property Management Company

From time to time investors ask me to refer property management companies to them.  I’m glad to do it as one of the advantages of being a commercial mortgage broker is that I come in contact with lots of property management companies. 

Years ago, it seems like another lifetime, I was a property manager.  I managed three Class A apartments totaling over 500 units.  I had 23 employees under me.  Being a property manager was the longest three years of my life.  I will never do that again.  So I have a lot of respect for those property managers who do their jobs well.  It requires a certain type of personality that I frankly do not have.    

In the course of my work as a mortgage broker, I inspect lots of properties, talk with a lot of on-site managers and get to review many different types of operating statements.  Over the years I’ve gotten to know the good property management companies from those that are grossly incompetent.  So what makes a good property management firm? 

There are lots of questions you could ask, however I would focus my questioning on three broad categories:

How do you charge for your services?  I’m aware of at least three different ways that property management firms charge their clients:

1.   The most common is a property management fee based of effective gross income.  Is their management fee competitive with what is being offered in the market? 

2.   Sometimes property management companies will charge you a hidden fee when using their maintenance personnel.  This can happen when a property doesn’t have a full time maintenance man and the management company’s maintenance man is contracted out at an hourly rate whenever needed.  Does the management company charge the owner of the property an hourly rate equal to their cost of employing their maintenance man or do they charge the property owner at an hourly rate that’s well above what it actually costs the property management company to have this person employed by them?  Many times the property management company is charging the property owner an hourly rate that is well above what it’s costing them to have this employee on staff.  If so, they are making money on you every time a maintenance item is being fixed on your property.  Just by looking at the Maintenance & Repair costs I can usually tell which property management companies are charging an excessive hourly rate for their maintenance personnel. 

3.   Do they charge the owner of a property an asset management fee?  If so is the fee a reasonable expense for the services rendered and again is it really a hidden profit center for the property management company?    

Are their operating statements easily readable and disclose all important information?  The quality of operating statements I see varies widely from hand written to very detailed computer generated reports.  Income and expense items to watch: 

1.   Do the operating statements begin with gross potential rent or do they begin with effective gross income?  In other words do the statements show vacancy, bad debt, and concessions?  If the statements do not show gross potential then owners can’t determine quickly how much vacancy the property is experiencing.   

2.   Do the operating statements show all payroll expenses including free rent?

An owner cannot make informed decisions on his property without having accurate and detailed operating statements that show the “good, the bad and the ugly.”

Can I help select my on-site manager?  No matter how good the property management company is, the on-site manager has the most influence on a property’s performance.  And the only way to determine the quality of an on-site manager is to observe how well they do their job.  I would focus on these issues:

1.   How is the property’s curb appeal?  Is trash found lying on the grounds picked up regularly?  Are trash enclosures hidden and well maintained so as not to be an eyesore?  Are flower beds weed free and attractive? 

2.   How well do they stay on top of collecting monthly rents?  Some managers are passive about collecting rents which over time will cause collection problems.  Other managers promptly post notices and stay on top of renters who pay slowly.

3.   How quickly do they get a unit ready to be re-rented?  In a tight rental market that we are in, every day a unit is waiting to be cleaned is money out of your pocket.  Ask the manager what type of system she has for getting units market ready. 

A good on-site manager is worth their weight in gold and can have a significant impact on the property’s cash flow.   The old adage, “You get what you inspect, instead of what you expect” is very true in property management.    

Choosing a property management company and an on-site property manager in many instances can make the difference between a property that does well and one that limps along.  Call me if you need a recommendation. 

John Mitchell and the Four Fairies

Last week’s blog post I referred to a presentation John Mitchell gave at the annual HFO Investor Roundtable event on January 8^th.  I specifically honed in on his comments about interest rates.  If you missed it, I would encourage to find the link to last week’s article located in the lower right hand column of this email under Recent Blog Posts and read the article. 

But there was also another part of his January 8^th presentation that I want to focus in on in today’s blog post.  Mr. Mitchell began this part of his presentation talking about his four year old granddaughter Stella who recently lost a tooth.  As Mr. Mitchell, heartily emphasized, “When your four years old losing a tooth is a big deal!”  And so it is because you get introduced to the Tooth Fairy who exchanges the tooth under the pillow for money.  When I was her age, I think the Tooth Fairy usually gave me a dime for my tooth.  I bet Stella received a whole lot more than a dime, at least I hope so. 

Mr. Mitchell then segued his discussion about the Tooth Fairy into the four fairies that many adults these days appear to believe in.  I thought his presentation was insightful, if not absolutely courageous, considering the likelihood of offending many of the people in his audience.  The four fairies are:

1.   The Free Medical Services Fairy – Think about it.  Medical services have never been and never will be free.  It takes real resources to pay for them.  Someone has to pay for them or they don’t exist. 

2.   The Entitlements Fairy – this fairy pays all the promises that our politicians have enacted through legislation down through the generations.  This fairy waves her magic wand and all entitlements are fully funded.

3.   The No New Taxes Fairy – this fairy may have died on December 31^st of last year but those who believe in this fairy believe that we are going to fix our fiscal crisis with no new taxes.  If you look at the numbers (most people don’t look at the numbers because ignorance is preferred over making informed decisions) what you find is that the sum of all federal revenues – corporate, personal, social security, tariffs, etc. there is just enough revenue to pay for Social Security, Medicare, Medicaid, interest on the debt and the federal retirement program.  The problem is there is another trillion dollars worth of spending that is left unfunded. 

4.   The Rich Will Pay Fairy – Again look at the numbers.  The top 1% of income earners pay 29% of all federal taxes; the top 20% pay 70% of all federal taxes.  Anyway you look at it the rich cannot fill the gigantic fiscal deficit that we have today.  I (Doug Marshall) have never understood how those who self righteously believe that the wealthy (I’m unfortunately not one of them) should “pay their fair share” think that it is perfectly okay that the bottom 47% of the population pays no federal income taxes.  Could someone explain that to me?  Whatever happened to the idea that all of us should pay our fair share of taxes proportional to our means?   

I want to end this article with two quotes which I believe are appropriate for our current fiscal situation:

“People only accept change when they are faced with necessity, and only recognize necessity when a crisis is upon them. “ Jean Monnet

“If something cannot go on forever, it will stop.” Herbert Stein

The fiscal path that the federal government is on is unsustainable.  Why not fix the problem while there is still time to act? 

John Mitchell’s Interest Rate Forecast

John Mitchell, a well respected economist, gave his economic update at the annual HFO Investor Roundtable event January 8^th.  It was another excellent presentation by Mr. Mitchell who has the uncanny ability of making economic forecasting interesting. 

To summarize Mr. Mitchell’s economic forecast, he believes we will continue to see an improving economy, albeit at a slow growth rate of about 2.0% annually.  Certainly this is nothing to be excited about but it’s far better than falling into recession.  

What I would like to focus my attention on today are Mr. Mitchell’s comments about where interest rates are heading over the foreseeable future.  So let’s first discuss what The Federal Reserve has been doing recently and then discuss what policies they intend to adopt going forward.     

·        From the standpoint of monetary policy, The Federal Reserve cannot push interest rates down any further.  Short term rates are near zero and they can’t go any lower than that.

·        The end of last month, The Fed’s Operation Twist was terminated.  This program manipulated the market by selling short term treasuries and purchasing long term treasuries which has resulted in driving down long term interest rates.

·        The Fed recently announced QE4.  Recall that quantitative easing is an unconventional monetary policy of buying financial assets from banks and private institutions thus injecting a quantity of money back into the economy for the purpose of stimulating economic activity.

Now let’s see what The Federal Reserve plans to do going forward.  QE4, as it is being implemented this time around, has two components: 1) the purchase of $45 billion of U.S. Treasuries a month with maturities in the 4 to 30 year range; and 2) the purchase of $40 billion a month of mortgage back securities.  Both types of purchases will keep long term interest rates artificially low. 

The Federal Reserve announced in December that they plan to keep interest rates exceptionally low as long as unemployment remains above 6.5% and inflation is no more than 2.5%.  Currently, the U.S. unemployment rate is 7.7%.  The buying of securities by The Fed is open ended until these two benchmarks are achieved.    

So the big question is: Do you think that the unemployment rate will decline significantly in 2013 or that there will be a jump in inflation this year in order for QE4 to be discontinued?  Not very likely is it?  As much as I would like to see unemployment fall below 6.5%, at the present pace of the economy we are likely two to four years away from that happening. 

Mr. Mitchell then posed a very troubling question to the audience: How will The Federal Reserve unwind QE4?  The Fed currently owns about $3 trillion in securities.  By the end of the year that number will be about $4 trillion.  Discontinuing QE4 will result in a significant “pop” in interest rates and selling the $4 trillion they currently own will further cause interest rates to rise.  Long term this looks like a gigantic problem with no easy solution.   

But back to the original question: Where can we anticipate interest rates to go this year?  It all depends on our economy.  There are two likely scenarios.

1.   If the economy continues at the current pace, then interest rates should stay where they are. 

2.   If the world economy begins to slow down at the end of this year due to the current recession in Europe and the economic slowdowns of other countries such as China, Japan and Brazil, then our economy will begin to slow down too.  If the U.S. economy were to show signs of a recession I believe The Federal Reserve will double down on its efforts to keep the economy going.  If true they would buy more securities which means interest rates would go down even lower than they are today.       

I believe there is no chance that rates will go up this year as long as QE4 is being implemented.  In fact I will go out on a limb and say I believe the second scenario is the more likely.  If true, then interest rates a year from now will be lower than they are today.   

Either scenario bodes well for commercial real estate.  Keeping interest rates low will continue the current trend of rising real estate values in the Pacific Northwest. 

Three Business Principles Steve Jobs Lived By

I had the opportunity over the Christmas holiday to read the excellent biography of Steve Jobs by Walter Isaacson.  Mr. Isaacson does not sugarcoat Mr. Jobs’s personality.  Steve Jobs would have been an awful person to work for as he could either profusely praise his employees or call them a piece of sh**, sometimes on the very same day.  To say the least, Jobs was a very difficult person to be around.      

That said, 100 years from now I believe he will be remembered as one of the great men of our era, held in the same high esteem as Henry Ford, Alexander Graham Bell and Thomas Edison. 

So what can we learn from Steve Jobs?  What made him unique?  What made him highly successful? There were many traits that made him successful, far too many to list in a short blog post, but I would like to mention three:

1.   He had an absolute passion for his work.  It was never about getting rich; it was all about making something he believed in.  He passionately believed in the Macintosh computer, the iPod, the iPhone, and the iPad to name just a few of the products Apple developed.  A recent survey indicated that 80% of Americans are not passionate about ANYTHING!  What are you passionate about?  Are you passionate about your work?  Do you find excuses to work late or come in over the weekend because what you do excites you?  Or do you even know what passion feels like? 

2.   He had an obsessive attention to detail.  There was a book written a few years back titled, “Don’t Sweat the Small Stuff… and It’s All Small Stuff.”  Jobs would have vomited his scorn on the author of that book.  Jobs was all about the small stuff.  “Good enough” was never good enough for Jobs.  Jobs was all about hiring the most gifted people he could find and then working them to their extreme limit.  Conversely he would also not hesitate to ridicule and quickly fire those who did not meet his high standards. He pushed and prodded his talented minions to perform at higher levels than they thought possible resulting in many technological breakthroughs that Apple is now known for.  He was absolutely ruthless on his employees but afterward they grudgingly loved and worshiped him for it.  How often do you settle for results that are less than your very, absolute best?     

3.   He was a “value creator.” He didn’t invent many things outright, but he was a master at putting together ideas, art and technology in ways that superseded what had come before.  Jobs once said, “Picasso had a saying, “Good artists copy, great artists steal” and we have always been shameless about stealing great ideas.”  Regardless of what we do for a living, our job boils down to adding value in the form of a product or service, for either our boss, if we have one, or our clients who are our ultimate bosses.  When we stop adding value, watch out, we’re expendable!  What can you do today to add additional value to your work so that your boss or client without hesitation realizes your importance in making them more successful?

I have heard people say, “Well I’m not Steve Jobs.”  Or they might insert another celebrity entrepreneur in that statement, like Richard Branson or Donald Trump.  Deep down what they are saying is that they don’t have the courage to try to be exceptional.  And I ask, “Why not?”  Being average is certainly not the road to success.  Yes, it is highly unlikely that we will ever be remotely as successful as Steve Jobs but should that stop us from living by the business principles that led to his great success?  I think not.     

My Crystal Ball Forecast for 2013

Forecasting reminds me of the quote attributed to one of our most famous philosophers of the 21^st century, Yogi Berra.  He said, “It’s tough to make predictions, especially about the future.”  But it’s that time of year when we all want to know what the new year is going to bring.  Specifically those of us in commercial real estate want to know, “How is commercial real estate going to do in the Pacific Northwest in 2013?” 

Well you’ve come to the right place because I’m bullish about the immediate future of commercial real estate.  Interest rates should remain low throughout 2013.  Commercial real estate should continue its upward trend out of our plunge into the abyss caused by the Great Recession of 2008.  Four years ago we were in a free fall, similar to a skydiver who waits as long as possible before he pulls the ripcord that opens his parachute.  It looked bleak.  Let me correct myself.  It was bleak.  But in 2010 we bottomed out and 2011 showed a modest improvement.  Last year was even better and there is no reason to believe this trend won’t continue into 2013.  

However there are three caveats to this prediction.  As James Carville once said, “It’s the economy stupid.”  And sure enough how well we do in 2013 assumes that the economy continues to grow at the modest pace that it has grown for the past few years.  If not, then all bets are off.  There are three things that could derail our economy. 

1.  The Slow Down of the World Economy 

Even though 70% of our economy is derived from domestic spending, the United States is not immune to what happens in the rest of the world.   And what is happening in the rest of the world?  Europe is in recession and the economies of other countries are slowing down.   This means that there will be less demand for our exports, which means our economy will begin to feel the affect.  However, I don’t believe that during 2013 we will feel the brunt of this slowdown to any real degree.   If the slowdown continues into 2014 and beyond then it is likely that it will slow our economy, maybe throwing us into recession as well but not this coming year.  

2.  Europe Muddles Through 

As I’ve discussed on several occasions, Europe’s sovereign debt crisis is not going to end well.  There is no satisfactory solution to their problem.  The only question is when, not if, it will implode.  The Europeans have been doing an excellent job kicking the can down the road these past few years and I’m guessing they will be able to further kick the can down the road through 2013.  If they can there will be little negative consequence this coming year to their sovereign debt crisis on the American economy. 

3.  Fiscal Cliff Outcome 

As of the time of my writing this blog post the Senate has just passed a bill to avoid the fiscal cliff but it has yet to be voted on by the House.  It’s hard to tell if this version will be acceptable to House Republicans.   At some point there will be an agreement, either this bill or one modified slightly to accommodate the House Republicans.  But let me let you in on a little secret, actually a big secret: It makes no difference which side wins the budget negotiation.  What both sides are proposing is equivalent to arranging the deck chairs on the Titanic.  They are haggling over nuance differences over how to raise tax revenues with almost no proposed spending cuts.  The proposed bill will raise about $1 trillion over 10 years.  That’s equal to $100 billion annually, which is an insignificant amount when compared to what is needed to right our fiscal ship.  So instead of having annual deficits of $1.2 trillion, we will have going forward $1.1 trillion in annual deficits.  So in ten years the total U.S. debt will go from $16 trillion to $27 trillion.  Sadly, no one in Washington has the courage to put our fiscal house in order.  Not the president, not the Republicans.  

Now the real question for 2013 is whether or not the stock market and the credit agencies perceive this miserable attempt at political theatrics as the sham that it is.  If not, then it will have no adverse impact on our economy.   If they do, the stock market will start to decline, possibly precipitously, and the credit agencies, such as Standard & Poors, may be forced to further downgrade the credit rating of our country.  That’s the potential fallout from the Fiscal Cliff.   Stay tuned.

If we can avoid these three pitfalls from happening in 2013, then our economy should continue to grow.  And with a growing economy commercial real estate in the Pacific Northwest should do quite well this coming year.   But the bigger issue is finding people on both sides of the aisle who have the political courage to get us out of our fiscal mess.

Lessons from My Father

Even though my father passed away several years ago I’m surprised how often I think about him.  Something happens during the normal course of my day, and it triggers a flashback of him.  It wasn’t a conscious decision to think about him, but rather some random thing happens and instantaneously I’m transported back in time forty years hearing my dad say or do something.  It happens all the time.  Does that happen to you?

My father in many ways was a good role model.  He also had his faults but as time passes the good memories of him are winning out and the not so pleasant memories are fading.  I hope that’s what happens with my two adult children when I’m dead and gone. 

As I said my dad was a good role model, but he was a lousy teacher.  I don’t ever recall him ever trying to teach me an important life lesson.  He just lived what he believed.  At the time, I didn’t understand the importance or appreciate what I was witnessing.  It was just my dad saying or doing what he always said or did.  It was nothing special, or so it seemed.  It was just vintage Dad.  But the older I get the more I appreciate the values that he lived.   

So what life lessons did I learn from my father?

LIVE WELL WITHIN YOUR MEANS

Growing up my family lived in a very middle class neighborhood.  The neighbor on our left was a grocer and the neighbor on our right owned a gas station.  Although my mom drove new cars, I can’t ever recall Dad driving anything but used pickups.  A vacation to us was visiting our relatives, certainly not going to a destination resort.  We lived quite modestly.  It wasn’t until I was in college that it dawned on me that my parents were financially well off.  Over the years there had been hints of my parent’s wealth but I hadn’t been able to put the pieces together.  That changed when Dad, who owned his own CPA practice, sold his business and retired at the age of 50.  He lived quite comfortably for the next 30+ years off the income generated from his investments.

TREAT EVERYONE EQUALLY

After retiring, my dad spent most of his days working on his tree farms.  Having grown up in the rolling farmland of Iowa he was in awe of the beauty of the forests in the Pacific Northwest.  About ten years before he retired he bought a parcel of logged over timberland and spent his weekends nursing the land back to health.  He was very comfortable working alongside loggers, foresters, and other blue collar workers associated with the forest products industry.  And they were equally accepting of him as one of their own.   

I’m not sure why (it’s a question I wish I had asked him) but he was politically well connected in Oregon state politics.  I remember back in the sixties he was a pallbearer at a funeral where a fellow pallbearer was Mark Hatfield, the then governor of Oregon.  Dad never showed preferential treatment to his wealthy friends.  Those in a lower socio economic class were treated no differently than the rich and powerful. He treated everyone with the same friendly Jimmy Stewart like manner. 

PUT TOGETHER WIN/WIN AGREEMENTS

Dad didn’t believe in win at all costs.  He proposed agreements that were fair for both parties, not just for him.  He had no problem leaving a little bit on the table if it meant getting the deal done sooner rather than later and with both parties satisfied. Sometimes the person he was negotiating with would attempt to take advantage of his desire to strike a fair deal and would respond back with some unrealistic and unjustified counter offer.  You see, not everyone plays by the same set of rules.  But for the most part, people intuitively understood that he was proposing an agreement that was fair to both sides and they respected him for doing so. 

Sometimes life’s most important lessons are better absorbed not through formal instruction but by the consistent actions of a role model over a lifetime. 

May God richly bless you and your family during the holiday season.  Merry Christmas!

Four Common Mistakes That Make Financing Your CRE Difficult, If Not Impossible

I’m surprised how often I am asked to find financing for a property that for one reason or another is obviously not financeable.  It’s as if the borrower wants the lender to forgo the use of common sense.  I’m going to let you in on a little secret: IT ISN’T GOING TO HAPPEN!!!  Anyone who is at all knowledgeable about commercial real estate lending realizes that lenders are risk averse.  They are not in business to take on any more risk than is absolutely necessary. 

So if you want to either refinance your property or to sell your property there things you must do a year or two before financing is needed to get the property to the point where I call it, “lender friendly.”  Not doing so will likely make it much more difficult, if not impossible, in getting a lender interested.  Here are four common mistakes:

1.   The property is in poor physical condition.  It’s a big turn off to lenders to see a property poorly maintained.  Why would a lender refinance a property for a borrower that is not willing to maintain his property?  If you want to refinance a property that has a lot of deferred maintenance you better have an excellent explanation as to why it’s in poor condition.  Better yet would be to get the big ticket items fixed prior to refinancing your property. 

2.   The occupancy rate for the property is below market calling into question the seller’s property management company’s ability to professionally manage the property.  If the property is self-managed you’re in deep trouble.  If the property is for sale some sellers or listing brokers think that providing a rent guarantee on the unoccupied space will satisfy a lender’s concern.  WRONG!!  It does just the opposite.  It’s a great big red flag that something is wrong with the property.  A better solution is to offer as much free rent as needed to get the vacant space occupied.  Offer the free rent at the beginning of the lease.  Once the free rent has burned off, then refinance or put the property up for sale.  You still need to disclose the free rent to the lender but it is much better to have your property at stabilized occupancy with free rent than to have a property with a high vacancy rate. 

3.   Operating expenses are well above normal for a property of that age and condition.  You need to investigate if there is a reason for this.  Is it an anomaly?  Are some ongoing maintenance expenses actually capital expenditures?  Can you explain why?  If you can determine that the additional expenses are costly one-time expenses then capitalize what you can identify and operate the property for a year to show what your operating expenses should be for a normal year.  If you rush to refinance the property with higher than normal operating expenses it will likely lower the loan amount because of the lender’s minimum debt coverage requirement.  And if you’re trying to sell the property, the value of the property will be adversely impacted because the NOI for the property will be lower than it should be.  Worst case scenario, the lower NOI could reduce the loan amount and thereby increase the equity required by the buyer beyond what he is willing to invest in the property killing your sale.      

4.   Most tenants are on a month-to-month basis (not a concern for apartment renters) or have only 1 or 2 years remaining on the term of their lease.  Most lenders will not accept rollover risk.  Again, proposing a rent guarantee on those tenants whose leases have expired or will expire shortly is a big turn off to lenders.  One way to mitigate risk is to identify when each tenant originally moved in.  If they have been a tenant at the property for 10 or more years then it is much less likely they plan to move once the lease expires.  But the best thing to do before you sell or refinance your property is to get as many tenants re-leased for as long as possible.  Once you’ve minimized the rollover risk then seek financing. 

Remember, it’s all about getting the lender as comfortable as possible with financing the property.  You’re asking the lender to lend you or your buyer lots of money.  Make sure to take some common sense steps prior to requesting a loan that makes it easy for the lender to say yes. 

Timing Is Everything When Financing CRE

They say that, "Timing is everything."  Right?  Well it certainly holds true when it comes to financing commercial real estate.  There are times during the year when trying to get a loan financed is pure misery and there are times when the financing "gods" are looking down benevolently on you.  But let me tell you a little secret: It's not rocket science to figure out when is the optimal time to get things financed.  It's plain common sense.  Shown below are the worst times and then the best times to get your property financed.

Worst Times to Finance CRE

1. June 10th through Labor Day - If you haven't signed your loan application before summer starts, good luck!  Summer is the time when kids are out of school and family's take long vacations.  Loan officers, underwriters, loan processors, real estate brokers, mortgage brokers, attorneys, appraisers, etc. all lose focus during the summer months and as a result the financing process slows down to a crawl, or so it seems.
2. November 1st through Year End - If your loan is not expected to close before year end, your deal will go to the bottom of the pile.  All the focus during the end of the year is to work on deals that will close before year end so loan officers can make their quotas and for those who have had a good year, to make their bonuses.

Best Times to Finance CRE

1. First Quarter - The best time of the year to start the financing process is during the first quarter.  Bankers are refreshed after the holidays and eager to start working on their annual quotas in order to acheive their year end bonuses.  Most insurance companies will be back in the market ready to lend.  As the year progresses, they become more and more selective on property type and quality of transaction.  
2. Labor Day through October 31st - People are back from vacations, kids are in school, and lenders are again eager to get their last round of deals started for the year so that they close before the holiday season. 
3. November 1st through the 15th - To paraphrase Charles Dickens, "These are the best of times and the worst of times."  No sane loan officer should commit to closing a loan in less than 60 days.  But those loan officers who haven't reached their quota, or have, but want to increase their bonuses even further go into "warp speed" trying to cram in the final deals for the year.  If the "moon and the stars" line up perfectly or they're just plain lucky they succeed.  I just found out late last week that I have a client that must close his commercial real estate purchase before the end of the year or he will experience adverse tax consequences.  There are less than 50 days to the end of the year and the deal is not yet under application.  I haven't closed a loan this year under 75 days, most have been considerably longer. And yet, I have four lenders who have committed to closing on this deal before year end. This just tells me there are a lot of hungry loan officers who want to get deals closed no matter what it takes. 

So when is the best time to finance commercial real estate?  It's plain common sense: Whenever your loan officer is highly motivated to get the deal done.

Source: The Importance of Luck and Timing in Real Estate, by Kevan McCormack, Metropolitan Capital Advisors

The 800 lb Gorilla in the Room

Whether Obama or Romney gets elected tonight, the next administration within the next four years will have two major crises that they will have to confront head on. One has been discussed frequently on the campaign trail – Iran getting a nuclear weapon, the other has been virtually ignored.  It's the 800 lb gorilla in the room.  We would prefer not to acknowledge that it even exists, which is, the inevitable financial collapse of Europe.

What most people don’t realize, or are unwilling to admit, there is no solution to the sovereign debt crisis in Europe. European leaders could assemble the brightest economist minds from all around the world together in one room, give them complete authority to act on the crisis as they see fit and it still would not change the ultimate outcome: Europe is going down. It’s inevitable. They are too far down the path to their own destruction to turn it around.

It’s only a matter of when, not if. True, they’ve done an excellent job “kicking the can down the road” these past three years and can continue to do so for some time to come but at some point the market is going to perceive their feeble attempts at a solution as putting a band aid on a gaping wound. When that occurs, market confidence will collapse taking down the European bond market and many of the European banks.

By now I suspect that many of you consider me a “nut job,” a “doom and gloom” type who thinks the world is coming to an end which I categorically deny. Humor me for a moment and for the sake of argument let’s assume my prediction is true. What then? How will this affect commercial real estate in the Pacific Northwest? To answer that question the following questions need to be answered:

• How will this affect trade with our largest trading partner, the European Union? We will see a substantial decline in our exports to Europe.
• How will this affect the U.S. economy? This will likely throw our economy into another recession.
• How will this affect our stock market? The stock market is affected by emotion. When things are good it soars far beyond any justification. When things are bad it plummets far lower than it should. In this case the stock market will initially plummet similar to what happened in 2008, maybe worse. At best it will be a roller coaster of a ride, soaring to new heights on good news and plummeting back down with any hiccup in economic news. This will not be a good time to be heavily invested in the stock market.
• How will this affect our bond market? It’s likely that Europeans will see our bond market as a safe haven and heavily invest in U.S. treasuries. If true, treasury yields, which are at historic lows, will likely go lower.
• How will this affect our financial institutions? This is where it gets ominous. The vast majority of our lending institutions should be unaffected. Only our five largest banks – Bank of America, JP Morgan Chase, Goldman Sachs, Citigroup and Morgan Stanley are heavily invested in credit default swaps on European sovereign debt. A credit default swap is a fancy term for bond insurance. Our five largest banks have insured a boat load of European sovereign bonds. When these European countries default on their bonds, these U.S. banks will be left holding the bag. Though these banks have confidently stated they have it under control, call me a cynic but I don’t believe them.  Between you and me, I hope they do. I truly hope they do because the alternative is these banks are going down.
• What response will the president (Obama or Romney) make to minimize the fallout on the American economy? This is where it gets interesting. The president has a very difficult decision to make: Does he let these five largest U.S. financial institutions go bankrupt? Or does he bail them out? Is the country in the mood to bail Wall Street out once again? Are these banks too big to fail? If he doesn’t bail them out will it not bring down the rest of the world’s financial system? Good luck Mr. President!
• So back to the original question: How will this affect commercial real estate in the Pacific Northwest? I think this can best be answered by looking back to the 2008 financial debacle. Four years ago some commercial real estate investors survived while others did not. The common denominator for survival was:
• Property type mattered. Apartments fared well. Office, raw land and single family subdivisions did poorly. Everything else was in between.
• Those properties that were modestly leveraged survived. Those that weren’t were taken over by the lender. 
• Those who have subsequently locked in long-term, low interest rate financing were the big winners.

When the Europe bond market collapses commercial real estate will be the investment that has the best chance to weather the economic storm. The stock market, on the other hand, will be a roller coaster basket case, the bond market will have incredibly low yields, and cash in the bank will yield no return. As long as investors invest in the right property type, leverage their properties modestly and lock in low interest rate, long-term fixed rate financing they will come out of this future economic crisis intact. And if inflation is the natural result of this disaster what better hedge against inflation than commercial real estate?

So am I a “nut job?” You decide.

John Mitchell's Economic Forecast - Is It Going to Stop?

I had the opportunity to hear John Mitchell’s economic forecast at the October 19th Commercial Association of Broker's breakfast meeting.  John always does an excellent job making a boring topic interesting.  There were no surprises in his presentation about the current economic situation, the gist of which was, the U.S. economy is growing, albeit at a slower rate than one would hope.

John began with a quick review of where we are:

• In the 4th year of economic expansion (hard to believe that's true but it is)
• 4.5 million jobs below our January 2008 peak
• 4.3 million jobs above our February 2010 trough
• 73 days until the Fiscal Cliff (read my previous post if you want a quick primer on the Fiscal Cliff)
• Globally experiencing economic weakness - Europe, Brazil, China, Russia, India are all either in recession or their economies are slowing down
• In the fourth year with short term interest rates at zero
• The Congressional Budget Office and the International Monetary Fund are both warning of a U.S. recession looming within the next several months

But I didn’t go to hear John Mitchell talk about our current economic situation. I went there to hear what he thinks will happen going forward. Accurately forecasting future economic trends splits the men from the boys, which reminds me of the Yogi Berra quote: “It’s tough to make predictions especially about the future.”

Not surprisingly, John Mitchell didn’t go out on a limb making any bold predictions about our economic future. Economists as a rule are not known for being risk takers. John Mitchell believes that our economy will continue to sputter along in the 2% growth range and that inflation will stay in check at about 2% for the foreseeable future as long as the Fiscal Cliff is handled responsibly.  

What was disconcerting to me was how negative his overall presentation was.  John by nature is an optimist.  He is always looking for a "silver lining." Normally if he says something pessimistic he tries to sugarcoat it with some positive news.  That was not the case this time.  My notes are filled with downbeat statistics.  The big three downers were:

• The economic recovery is growing at an historically slow rate when compared to all other economic expansions since WWII. 
• The Fiscal Cliff.  Congress and the president need to work together to avoid an economic crisis of their own making.  If not handled properly it will throw the U.S. economy into a recession.
• Monetary Policy.  The Federal Reserve is out solutions and nothing has worked.  Interest rates are at historic lows, Operation Twist, and Quantitative Easing have had only modest impact on the economy.  

When he got done, I had to fight the urge to give him a big hug and tell him things will get better. 

Whether that is true or not will depend in large part on who we elect in November.  I hold out no hope if President Obama is re-elected for another four years.  I'm not sure he even acknowledges that we have a serious debt crisis that will take us down the same path that Europe is traveling if we don't do something about it soon.  Mitt Romney talks a good game.  He at least says the right things but I'm skeptical he will have the courage to make the hard choices to get us back on track.  Is he a statesman or just another politican saying whatever is necessary to get himself elected?  I'm sure I've just offended both the Democrats and Republicans that read my blog.  Sorry.  I consider myself an equal opportunity offender.