International appraiser

Appraisal in Nayarit, Mexico

2012-02-10T13:20:00.000-08:00

This appraisal assignment illustrates the problems in obtaining reliable Mexican market data.

The subject property is about 100 hectares of raw, beachfront land located on the Novillero Peninsula in the state of Nayarit, about a two-hour ride south from Mazatlan, Sinaloa on Mexico’s west coast. Playa Novillero has the distinction of being Mexico’s longest continuous beach, at 82 kilometers. The beach itself is not particularly impressive, consisting of dark colored sand and lacking distinctive physical features, but it does have coconut palms and is quite wide and flat.

Unlike the Mazatlan area to the north and the Nayarit Riviera to the south (close to Puerto Vallarta), the Novillero area is characterized by abandonment rather than development. I saw no new development, but plenty of abandoned beach homes. One problem is the lack of good road access to this area.

Abandoned Novillero beach homes

Prior to my arrival I was told that the owner had acquired the parcel in 1998, had received an offer of $7 million for the property and had a Mexican appraisal estimating value to be about $5.9 million.

When I obtained the escritura (deed), however, it indicated that the owner had purchased the property a year ago for only about $85,000.

Which number more accurately reflected market value? Most likely, none of these numbers, for the following reasons:

1. The only honest Mexican appraisal I’ve ever seen was one I ordered myself.

2. If I took “offers” seriously as indicators of market value, my lender clients would have ended up foreclosing on allegedly $50 million worth of scattered woodlands in rural Tennessee, an allegedly $100 million mountain in northern California, and an allegedly $100 million beach parcel on the northern end of Padre Island.

3. It is standard practice in Mexico to understate sales prices in deed transfers in order to minimize the 2% transfer tax required of the seller. It doesn’t matter that it is also illegal tax evasion witnessed and sanctioned by notary publics; the tax laws do not seem to be enforced.

I did ask the property owner to tell me whether the deed was correct, to which he indicated no, and then submitted documentation that he actually paid over $1 million, more than 12 times as much as was recorded, which seemed credible in light of the comparable data.

For raw, unimproved beach parcels in Nayarit and Sinaloa, the ceiling of value appears to be about $2000 per lineal meter of beachfront outside the major resort areas.

Next stop: Bahia, Brazil

When real estate scoundrels pretend to be saints

2012-01-31T14:10:00.000-08:00

"As God is my witness, I can GET YOU FINANCED!"

Now that Andy Rooney has passed away, it’s my turn to talk about what annoys me most. In the commercial real estate industry, I am annoyed by real estate scumbags-turned-saints.

Now we all know that the real estate industry does not naturally attract saints. It may attract sincere people, but mostly people who just sincerely want to become rich.

Sometimes, when a convicted fraudster, perhaps a mortgage broker, is led from court in handcuffs, he or she may say, “But I was making the dream of homeownership a reality for underprivileged families!” in a tone of voice so sanctimonious as to make one wonder why Mother Theresa herself wasn’t a mortgage broker, too, until one considers that people with bad credit who lie about income and assets might not actually deserve homeownership.

Those people who must announce their integrity!

“The louder he proclaimed his honor, the faster we counted the spoons”--Ralph Waldo Emerson

Two weeks ago I received a comment on my Costa Rican tree farm scams blog which basically said that my comments did not apply to a company named Ethical Forestry, which owns teak farms in Costa Rica and uses telemarketers to lure UK citizens to invest in individual trees.

If the proof of integrity is in the name of the company, this gives me an idea to create the Ethical Bridge Company. The company’s purpose will be to ethically sell the Brooklyn Bridge, not like all those other Brooklyn Bridge salesmen who give bridgeselling a bad name. 10% of your purchase money will be used to buy wheelchairs for crippled orphans.

It may be no coincidence, too, that the only client who ever cheated me out of my fee proclaimed his Christianity in every conversation we had. Have a blessed day in Hell, Mr. Scott.

Those ethics awards!

A developer once deceived my bank into making a $30 million land speculation loan at a 5% interest rate and 97% loan-to-value ratio. The loan was allegedly for the purpose of constructing a surface parking lot supposedly worth $65 million, according to their appraiser (but had just been bought for $24,375,000). When I raised doubts about the developer’s intentions, the loan officers dismissed them, pointing out that the developer had just received an “ethics award” from a realtors’ organization. Ethics awards from realtors? What could be next -- a humanitarian award from Osama bin Laden?

In any event, the Chief Lending Officer who rigged this deal is now being sued for $300 million by the FDIC (Federal Deposit Insurance Corporation).

Those philanthropists!

Eighteenth century philosopher Samuel Johnson once said “Patriotism is the last refuge of a scoundrel.” Let me update Johnson by adding the word “philanthropy” to the list. Some of the best known “robber barons” of the 19th Century (and at least one from the 20th) became philanthropists. My alma mater, the University of Chicago, was founded by one such philanthropist, John D. Rockefeller. Bernard Madoff was also a known philanthropist.

Take Richard Simring, for instance, a co-conspirator to Ed Okun, who I mentioned in my international real estate syndication fraud blog. Before confessing his guilt, he was also serving as the Chairman of the Board of the Voices for Children Foundation, a charity that raised money to advocate for abused or neglected children, in addition to serving the Lighthouse for the Blind and serving on the board of directors of Educate Tomorrow, a foundation making education attainable to children in the third world nations of Niger and Miami, Florida.

Young Irish real estate mogul Darragh MacAnthony dropped out of college to sell timeshares in Spain and ended up founding MRI International, which took funds from UK and Irish investors to buy overseas vacation homes and furnishings. The company was headquartered in Spain and went into liquidation in 2009, and hundreds, if not thousands, lost their cash deposits, for which MacAnthony faces Spanish litigation for “theft by swindle and misappropriation of funds”. He is also chairman of the Helping Hands Group, a charity that provides free transport, training and physical therapy to brain-injured or learning-disabled adults, and chairman of the Peterborough United Football Club. What a nice man. Meanwhile, an “MRI Victim Support Group” of more than 800 members has protested in from of the UK Prime Minister’s House (10 Downing Street).

The real estate industry often accommodates such paradoxes. When I was in banking I sometimes had to bear the unpleasant news that we had been deceived by a borrower, only to hear an admonishment such as “How dare you question his integrity! Don’t you know he’s chairman of the Pathetic Crippled Children’s Foundation?” Charity and honesty are not necessarily synonymous, and I hypothesize that the biggest crooks often turn to charitable giving to assuage the guilt they feel in receiving ill-gotten gains. Everyone wants to feel good about himself.

“Martin, before you call this man a liar, you should know that he’s chairman of the Pathetic Crippled Children’s Foundation.”

Appraisal in Perth, Australia

2012-01-30T22:02:00.000-08:00

This is my third appraisal assignment in Perth. This assignment is similar to any appraisal of a Class C downtown office building in the U.S., only that Perth is experiencing classic “boomtown” economic conditions as a result of it being the corporate hub of the Western Australian mining industry. Chinese demand for Australian minerals has created a huge economic boom for this region, which had previously been languishing between the years of 1990 and 2005.

Price inflation in Perth has been so profound that a can of coke in a convenience store costs 2 Australians dollars (equivalent to $2.12 USD) and a McDonalds breakfast costs 3 times the price in Los Angeles. My host told me that his son is a truck driver earning $180,000 per year, and when I asked other Australians, they confirmed that it was an ordinary wage for Western Australian truck drivers. Some of my appraiser friends in LA would gladly cross the ocean for work paying like that.

The subject property is an older office building constructed in the 1960s and showing its wear. The owner has a plan to renovate the building into commercial condominiums (AKA “strata” in Australia and the UK) and a conditional commitment from an Australian bank once the renovation has been done. My client was to serve as a bridge lender in the mean time and was only interested in “as is” value, however.

The building is 92% occupied in a CBD office market with 96% occupancy, and is predominantly occupied by an English language school and a commercial fitness center.

An English language school is a good tenant to have in Perth, which is very much a city of immigrants. I did my own informal survey of the locals, asking “Are there too many immigrants in Perth?”, to which 28% responded “Yes”, 20% responded “No” and 52% responded “No speak English”. OK, I made this all up – just trying to keep you readers awake.

The main Perth office district, though, is located two blocks south of here on St. Georges Terrace and Adelaide Terrace (same street, two names), and includes high-rise office towers adorned with the names of major banks, whereas the subject is in a secondary, lower-density location of older buildings, some dating back to the 1920s, and can be characterized as a middle-income pedestrian retail environment. There are several nearby restaurants serving either Kebabs or Korean food, for instance.

As is sometimes the case in appraising properties slated for renovation, the owner wanted me to appraise the property as if renovated and subdivided into condos (or strata), whereas the lender was only interested in “as is” value, or what they could sell the property for tomorrow. Despite Perth’s booming economy, it is interesting to note that office buildings trade at capitalization rates in the 8 to 10% range, well above those of California, possibly indicating either that Australian real estate investors have less appetite for risk than U.S. investors or else that there is a feeling that the Western Australian gravy train might not last forever. The fortunes of this region are very tied to China, and if China sneezes, Perth could catch pneumonia.

PS: I've found another low-cost way to get to Australia from the U.S. (besides the unreliable Air Pacific) -- China Southern Airlines. The connecting point is Guangzhou. The Chinese air hostesses are eager to please, but haven't quite mastered conversational English. They serve meals in record time, but when they ask "May I take away your plate?" I found that my standard answer, "Not yet" sounds like "Yes" to their ears. Be sure to watch the hilarious "in-flight exercise" videos, in which two robotic, unblinking air hostesses perform Tai Chi-inspired exercises while the narrator explains the ancient Chinese medicine justifying each exercise. For example: "Subdue the liver, extinguish the wind." What wind would that be?

Next stop: Nayarit, Mexico.

Those “Guaranteed Income” Rental Home Investments

2011-12-30T09:38:00.000-08:00

Rental condos in Kissimmee, Florida

A recent inquiry from a Canadian journalist has me revisiting this topic, as there is now a burgeoning industry of selling “rental home investments” to foreign investors, particularly the Canadians and the Chinese. For instance, some unsuccessful builders of failed subdivisions in places like Arizona and Nevada are advertising their unsold homes as “rental home investments” for which they or their agents promise to rent and manage for foreign investors. Their ads often tout “guaranteed ROI of xx%” or “guaranteed rental income for two years”. Are such investments a good deal?

“Guaranteed rental income for the first two years” is a seller promise that should be interpreted as a sign of weakness, not security, because a rental property in a stable market need not be sold with any such guarantees. What often happens, too, is that the property’s previous asking price has been inflated to more than cover the amount of these guaranteed rents.

Enforceability of guarantees

Guarantees are not quite guarantees if the builder or manager goes out of business, even if just to emerge again as another legal entity (for example, if the principals of Get Rich Quick LLC dissolved their LLC and reorganized as Get Rich Guaranteed LLC). If the guaranteed rents stop coming in, there is also the logistical problem of filing a lawsuit far away from home to collect what is due, and foreign investors are at a disadvantage in negotiating the complex U.S. justice system. Accept this common piece of advice from Craigslist:

“Only a scammer will ‘guarantee’ your transaction.”

Recommended Due Diligence for U.S. rental homes

1. Try to get vacancy rate data for the community the home is in at the most granular level, whether it is the subdivision, the zip code, or the census tract. One helpful tool at the moment is the U.S. Census, which recently completed a decennial census with data as of April 1, 2010. The U.S. Census Bureau counted vacant housing units as of that date and will soon publish data down to the census tract level. For instance, realtors crow about Green Valley, Arizona, being the second fastest growing town in Arizona, itself one of the fastest growing states, all according to the U.S. Census, but may neglect to mention that in Green Valley, a suburb of Tucson, the Census counted 4581 vacant housing units out of a total of 17,322, equivalent to a vacancy rate of 26.5%. What will happen to a rental home there after the guaranteed rental income runs out after one or two years? Tucson isn’t much better, having a 15.9% rental vacancy rate.

2. Google the name of the seller and the management company and look for consumer and investor complaints. It helps to add the words “scam”, “fraud” or “complaint” to your search terms to get beyond the pretty web sites of the scammers. Try “MRI Overseas Property scam”, for instance. The really active fraudsters, though, will publish articles designed to show up in such search results, such as “Get Rich Quick LLC – No Scam!” or “Guaranteed Riches, LLC – No Complaints Here!”, and may even write their own highly favorable Wikipedia article, so keep on searching all the results. If the company is so new that nothing can be found in a background search, Google the name of the principal of the company, and that’s often where you will find a history of a swindler moving from state to state or even nation to nation to perpetrate scams.

After applying the aforementioned screening criteria, you should have a much smaller list of prospective investments.

The Weakest Link in Appraisal/Valuation Reports is the Information Supplied by the Property Owner

2011-12-18T20:11:00.000-08:00

Some of my previous blogs have touched upon this subject, whether it was the Jakko Poyry forest valuation report that SinoForest investors relied upon to their detriment (including John Paulson, who lost more than half a billion dollars), or the valuation report relying on false financial statements in the case of the Beijing Gateway Plaza fraud, or the Costa Rican appraisal report based on false representations of the property having full development entitlements.

The commonality in these instances was that an appraiser or valuer unwittingly relied upon false statements made by a property owner, resulting in a flawed valuation.

About 70% of my work is domestic (within the U.S.), and recent assignments have reminded me of the pervasiveness of this problem in the real estate appraisal/valuation profession throughout the world, including the U.S. In most English language valuation reports, for instance, one finds a standard exculpatory statement similar to the following:

“No responsibility is assumed for accuracy of information furnished by the property owner.”

This is the Achilles heel of the appraisal profession throughout the world –-acceptance of inaccurate information from biased parties without verification. Some appraisers in high places even contend that it is not an appraiser or valuer's responsibility to verify such information. "Who am I, the fact police?" asked one. Yes, you should be.

Last week I was appraising an isolated “cave lodge” in hillbilly country. A New York area hotel valuation firm came in before and appraised it for $5 million based on the owner’s representations of renting it out at nightly rates of $1000 to $1800 for more than 85% of the year, with annual revenues of $368,200. No efforts were made to verify these revenues despite their implausibility and lack of customary expense categories, such as Payroll expense.

I asked for tax returns, both Federal income tax and state sales tax returns, and got a runaround with plenty of excuses and contradictions. The owner finally admitted that he has paid no sales taxes on his lodging revenues, and the only Federal tax return produced indicated revenues of about $36,000, or about 10% of what was previously represented.

My favorite tall tale was when the owner told me that Cher had rented the place for a Halloween party last year. He should have picked a more mysterious celebrity, as Cher is a known concert performer, and it has been well established that she performed in Las Vegas (more than 1500 miles away) on Halloween night last year, and there are unauthorized YouTube videos to prove it.

A few weeks ago I was also asked to look at a vacant, 85-year-old multi-story warehouse. Two appraisers had relied on the owner’s representations and had made “extraordinary assumptions” that the elevators were operational (they were not) and relied on owner representations of “clear height” (the height to which goods can be stacked) and building area, apparently not measuring the building. Although the warehouse had been purchased for $430,000 in 2005, at the top of the market, and has remained vacant and unsold since then (having been listed for sale and lease in the mean time), both appraisers now estimated value to be about $2 million.

Conclusion

An appraisal or a valuation is only as good as the data and assumptions that it relies upon. Garbage in, garbage out. It is time for users of valuation services to ask questions about the reports they rely upon, questions such as “How did you verify this?”

Three Appraisals in Britain

2011-12-02T22:03:00.000-08:00

London bed-and-breakfast inn

After Cozumel I flew to London, England, to appraise a portfolio of hospitality properties – a bed and breakfast inn and two restaurant/pub buildings in London, Windsor and Buckinghamshire.

My client, a private U.S. lender, had already received valuation reports prepared by British chartered surveyors which proved that the United States and the United Kingdom are two great nations separated by...a common language. Terms like “chartered surveyor”, “lettings”, “trading potential”, “realisable”, “consents” and “solicitors” are confusing to Americans in the context that they are presented in British reports. The reports reminded me of a classic “I Love Lucy” episode in which Lucy attempts to get walking directions in London. One reason I think that U.S. clients send me to appraise in so many British Commonwealth nations is that I write appraisal reports in American English and try to follow North American (US and Canadian) reporting standards.

I worked the first three years of my commercial appraisal career at a British company, Jones Lang Wootton. (JLW was eventually acquired by LaSalle Partners and the new entity was named Jones Lang LaSalle under different ownership and management.) Thus I have worked under both real estate valuation regimes and have some knowledge of British valuation methods and jargon.

The English properties

Restaurants and bed-and-breakfasts are not usually very profitable enterprises. While I don’t have current figures, a traditional rule-of-thumb has been that 80% of restaurants and bars do not last five years. Bed-and-breakfasts have had a similar failure rate, as they are often founded by amateurs.

As luck would have it, though, all 3 properties were owner-occupied and consisted of valuable real estate. The London metropolitan area, much like New York City, has a general shortage of available land for new construction, and a well-constructed building often has an intrinsic value independent of the relatively unprofitable businesses which may occupy it.

The London bed-and-breakfast, for instance, had previously been used only as a 12-bedroom residence. Similar residential sales in the area suggested a value of about one million pounds, a value not otherwise justified for a bed-and-breakfast business with a net income of less than 40,000 pounds per year.

The restaurant/pub building in Buckinghamshire had apartments on the second floor and was also situated on a block with one-million-pound residences, but the value had to be adjusted downward for the cost of conversion back to a residence. Pub sales in the area were at considerably lower prices in the range of 350,000 to 450,000 pounds, so my highest and best use analysis, considering the restaurant’s financial statements, established that the property was not being used in a manner which maximized value.

One nice thing about working in the UK is the availability of residential sales data. It is all contained in a national registry, unlike the United States. Similar to the U.S. is the prevalence of automated valuation technology, including free AVM technology, such as the Zoopla and Mouseprice web sites, which are similar to Zillow and Trulia in the U.S.

The restaurant in Windsor was more difficult to appraise, partly because it consisted of 3 adjacent buildings, one of which was owned only as leasehold. The leasehold building’s annual rent of 60,000 pounds per year (equivalent to $93,600 at today’s exchange rate), when compared to restaurant revenues, strongly suggested a negative leasehold value for these premises, which were not being fully utilized, and the leasehold building would therefore not be suitable for loan collateral. In addition, the entire restaurant property was not configured or located in a manner befitting a residential highest and best use.

Most of the restaurant operations seemed to be actually conducted in the freehold (fee simple owned) buildings, thus suggesting continued viability of a restaurant business if the lender had to foreclose on two of the three buildings.

In the end I relied most upon a gross rent multiplier method for the Windsor property, but estimating market rent as a function of the revenues earned by the restaurant operations. Finding comparable restaurant rentals is a difficult task, as restaurants are retail properties that can have significantly different rental values based on location and visibility. Very few leased restaurants, though, can afford rent beyond 8% of gross revenues, which limited affordable rent to about 61,000 pounds per year for this particular operation if it was a rental operation. While it could be argued that a more profitable restaurant operator could justify a higher rental rate, the occupying restaurateur was already a highly experienced restaurateur and celebrity caterer.

Differences between British and North American commercial appraisals

The British “valuer” is much more likely to have collegiate instruction in real estate and building subjects; North American (Canadian and American) appraisers typically receive their appraisal education from professional associations or trade schools after college. Present-day certification and designation requirements for U.S. commercial appraisers require them to hold baccalaureate degrees (unless “grandfathered in”), but the degree can be in any subject and often is. Americans do not typically train early in their lives to become appraisers; they accidentally become appraisers.

North American appraisal reports, on the other hand, are more complete and try to be prima facie cases in support of estimates of value. British reports are briefer, do not demonstrate the analytical process used, do not present a “highest and best use analysis” (as in “would this building achieve the highest value as a residence or as a bed-and-breakfast?”) and do not typically present photographs or maps of comparable sales and rentals. They cannot therefore be reviewed critically by a foreigner. In other words, there is no basis for the reader to judge the competence or honesty of the valuer.

Working alongside British valuers, though, I sensed that they perceived more honor for their profession than North Americans appraisers do. There seemed to be more emphasis on honesty in their work, although there were certain practices that Americans would label as unethical, such as charging a professional fee as a proportion of the appraised value, which presents a conflict of interest. That being said, I trust the honesty of British valuation reports more than North American reports when I do not specifically know the appraiser or valuer.

Still, the considerably lesser British valuation reporting standards can be a cover for sloppy work. The most egregious case I saw at Jones Lang Wootton was in the appraisal of a portfolio of over 200 surplus bank branches as a result of the merger between Wells Fargo and Crocker Banks in 1986. The Director of Valuation saved the premier property for himself to appraise, the Wells Fargo Tower in downtown Los Angeles. When he arrived at an internal company meeting to go over final values, it was clear that he had not done his homework. He said, “So what’s a downtown L.A. office building worth, any way? $200 per square foot?” The chartered surveyor from San Francisco yelled out, “No! $300 per square foot”. “Well, then $300 per square foot it is,” said the Director of Valuation and the supporting two-page report quickly got written.

It is hard to judge professional ethics enforcement in either country. The Appraisal Institute, the most highly regarded of the several U.S. appraisal associations, has an ethics enforcement staff of just one, and she has been in situations of siding with appraisers who have already been disciplined by state appraiser licensing agencies; it is rare for a member of the Appraisal Institute to be expelled for ethical violations. RICS, the governing body over British Commonwealth valuers and many other types of real estate professionals, is said to have an ethics enforcement staff of about 3 dozen persons, a considerably more impressive number.

Yet, a few years ago when I pointed out to RICS that their international president was a U.S. appraiser who had actually lost his appraisal certification due to disciplinary action, RICS investigated and informed me that he did nothing wrong and voluntarily surrendered his certification in order to obtain an appraisal certification in another state, an action not required in the U.S., as I have held as many as 5 concurrent and different state certifications at one time. The Appraisal Subcommittee web site (www.asc.gov) publishes the names of all appraisers who are no longer licensed due to disciplinary action by a state agency, and his name is there, one of about 50 in his state.

Professional organizations cannot really be expected to police themselves well, though, due to professional friendships, potential "loss of face" and a prevailing sense of "There but for the grace of God go I," particularly when appraisers and valuers are constantly confronted with ethical challenges.

I am also skeptical of the massive RICS recruitment effort in the U.S., as RICS does not offer an educational program or testing here. A U.S. appraisal designation plus $500 per year gets one an MRICS designation, but what does that all really mean if RICS is not educating or testing here? It seems that their main goal is to collect $500 each from as many U.S. appraisers as possible without contributing to our profession here.

Some of my colleagues told me they pursued an MRICS or FRICS designation in order to solicit international work. As someone who worked at a British-owned international firm, however, I was never encouraged to pursue an RICS designation, but encouraged to pursue an MAI designation instead. Since then, I have worked many times in British Commonwealth nations
(Australia, Canada, Jamaica, Barbados, South Africa, Fiji, Singapore, Malaysia, Hong Kong and Great Britain) and not been asked if I have an RICS designation. Moreover, when I have called on RICS members in these countries, most have been cost estimators ("Quantity surveyors") rather than valuers.

Capturing the best of both systems

A British subject named John Lennon once wrote a memorable song called “Imagine” shortly before moving to the United States in 1971. Imagine if the English-speaking appraisers of the world could capture the best of both the British Commonwealth and North American systems, with British-style collegiate instruction and sense of professional honor coupled with the more descriptive and informative appraisal reporting standards found in the United States, while agreeing on a common professional vocabulary?

You may say that I'm a dreamer, but I'm not the only one.

Condo project appraisal in Cozumel

2011-11-21T17:35:00.000-08:00

I am currently revisiting a condo project in Cozumel, Mexico, that I appraised three years ago. Cozumel is an island off of Mexico's Yucatan peninsula, a land full of lush tropical jungles and Mayan pyramids.

This particular condo project had a successful, sold-out first phase, but by late 2008 it was apparent that many vacation condo projects all over the world were in trouble. Many condo projects that I was visiting had stopped making sales altogether.

This project in Cozumel was faring slightly better; its rate of sales was down only 50% due to one of Cozumel’s unique attractions– it is a mecca for scuba divers from all over North America. Condo buyers at this particular project were typically both doctors and scuba divers, and the recession had hit this population subgroup less severely. Still, the forecast of a prolonged absorption of the unsold units resulted in a decision to not fund the construction of another phase. It was hoped that another lender would step in, but as can be seen in the photo, construction has been halted since 2008.

General worldwide conditions for vacation condos

The last three years or more have been difficult for second-home markets all over the world, as I have witnessed in such far-ranging locales as Barbados, Fiji, the Dominican Republic, Costa Rica and Canada.
Many of the failed overseas second home projects were high end luxury projects focused on a growing number of “multi-millionaires” in the world. Each project tried to achieve a certain prestige by promising top shelf amenities vital to the ultimate success of such luxury projects.

Unfortunately, the market for vacation real estate is discretionary, and the purchase of vacation real estate has moved further down the priority scale for a large number of potential buyers. For instance, one of the main motivations for the purchase of vacation real estate has been the potential for financial return from the investment. While there were forces in place for price appreciation in advance of the recent financial crisis, buyers now recognize that the potential for appreciation of luxury second homes has significantly deteriorated. As for the ability subsidize ownership costs or earn a return on investment by renting out one’s property, a worldwide oversupply of vacation homes is driving down returns on investment.

Another concern from likely buyers relates to the continued financial viability of substantially unsold projects, and the risk of promised amenities not being built or else operating at a substantial deficit which would require increases in homeowners association dues. For instance, many golf course sales nowadays are to homeowners associations trying to rescue an affiliated golf course from bankruptcy. That often requires a substantial increase in POA dues.

In addition, the allure of owning a home in high-end vacation communities comes from the prestige of belonging to a successful community. The financial distress and litigation associated with an unsuccessful project may instead have the opposite impact. Being associated with a troubled project affects the psychology of potential luxury real estate buyers. Instead of looking savvy, a purchaser could now look naive. This makes the proposition for purchase due to a project’s prestige more difficult than before.

The valuation of a failed project is exceedingly difficult, as it typically takes several years to get such a project restarted if at all. Patient capital is required, and it is difficult to construct a discounted cash flow model that can correctly forecast the timing of the project’s turnaround.

Other Yucatecan ruins

The following photos are of ruins left behind in Cozumel by an ancient, post-Mayan race of people known as "speculative real estate developers".

Next stop: London

South African update: Will the ouster of Malema stop the decline in farm values?

2011-11-13T17:30:00.000-08:00

In my last report on South Africa, I mentioned two possible factors in the price decline for South African game farms. One factor was the overall world surplus of vacation properties for the super-rich, and the second factor was political rhetoric calling for uncompensated government expropriation of white-owned land, rhetoric amplified by a rising star in South African politics, Julius Malema, the ANC’s Youth League President. Last Thursday, Malema was removed from his position and suspended from ANC for five years for bringing disrepute to the party, because of his divisive speeches within South Africa as well as his interference in the politics of neighboring countries. He has been constantly opposed by President Jacob Zuma.

The removal of Malema may help restore investor confidence, although the Johannesburg Stock Exchange All Shares Index was up by less than one percent after his sacking. The JSE AS index was hit hard earlier this week by a sovereign ratings downgrade from Moody’s.

Expropriation of white-owned properties

Confiscation of white-owned properties occurred during the 1990s in nearby Zimbabwe (formerly known as Rhodesia) and has resulted in a decline in agricultural productivity there and an overall implosion of the economy after a period of hyperinflation.

At end of the Apartheid Period of South Africa in the 1990s, 87% of commercial farmland was white-owned, and the new ANC-led government pledged a compensated program of land redistribution that would transfer 30% of white-owned land to blacks. Progress has been slow, and whites still own 84% of commercial farmland.

It is difficult to calculate the effect of the removal of Malema in restoring real estate market confidence. The ANC Youth League which he presided over still insists, after his ouster, on the nationalization of mines, a similar issue, and this matter is still being actively studied by the African National Congress despite the insistence of national leaders that it would never happen.

One problem also besetting the agricultural sector is the high murder rate of white farmers, most who are allegedly killed during ordinary robberies rather than politically motivated violence. More than 3000 farmers have been murdered so far, a very alarming number, and Malema's removal will have little effect in stopping this trend. south

The Appraisal Institute has published my new book

2011-10-14T16:08:00.000-07:00

Soft cover, 122 pages

ISBN: 978-1-935328-22-3

Stock Number:0751M
Fraud Prevention for Commercial Real Estate Valuation
Vernon Martin, CFE
Appraisal Institute
Price: $45.00
Member Price: $35.00
Plus shipping and handling

Direct link to Appraisal Institute book ordering web site: http://www.appraisalinstitute.org/store/p-283-fraud-prevention-for-commercial-real-estate-valuation.aspx

This is the Institute's description of the book:

"Mortgage and investment fraud are at an all-time high and there are serious consequences for appraisers who become involved in suspicious transactions. This book describes common methods of deception used in fraudulent schemes involving commercial properties and land. It presents various situations and conflicts of interest that have the potential to exploit the appraisal process for dishonest purposes.

Appraisers who can detect fraud can protect themselves from relying on inaccurate information that could compromise the valuation analysis. By thinking critically and challenging assumptions, commercial appraisers can keep out of trouble, whether it is trouble for themselves or for others who rely on their work.

Order now and arm yourself against real estate fraud!"

A note to my most faithful readers:

My previous book, "Lessons from Losses in Commercial Real Estate", is being retired due to my new venture with the Appraisal Institute. Although the overlap between the two books is small, the Appraisal Institute does not want me to compete with them with another book, and that is fair.

The Reasons Behind the Overbuilding of Luxury Retail Malls in China

2011-09-26T16:23:00.000-07:00

Some readers may have mistakenly ascribed a political agenda to my postings about Chinese real estate. My views on commercial real estate are nonpartisan and non-ideological.

To those who think that I have been poking fun at “The Communists” or the Chinese government, I point out that the fiascos I've reported have been capitalistic decisions of private owners and investors which happen to have occurred on Chinese soil. (Only one, New South China Mall, had some government involvement, as it was financed by the Agricultural Bank of China, which was State-owned at the time of funding nine years ago.)

I even disagree with the notion that the People’s Republic of China is a communist society. During my trips to the PRC I’ve met many Chinese people, none who have ever expressed the sentiment that he or she wanted to create a classless, utopian society that benefited “The People” rather than themselves. Most just tell me “I want to be rich”. If I ask for an opinion of Chairman Mao, I generally get a strange look which implicitly asks “What century are you living in?”

As part of enforced “general education” requirements as an undergraduate at the University of Chicago, I was required to read The Communist Manifesto and The Russian Revolution (strictly in the context of critical inquiry), and neither Karl Marx nor Lenin ever stated that “The People shall have an Omega watch store every four blocks.” or "From each, according to his abilities; to each, a Gucci handbag." Overbuilding is not a Marxist concept, but Marx did explain in Das Kapital that overproduction is part of the natural outcome of a capitalistic society.

Karl Marx has probably caused more human suffering than any other philosopher who ever lived, but his criticism of capitalism was often insightful. He explained that technological advances increase labor productivity, which increases material wealth in the ruling classes while diminishing wages of workers, creating “poverty in the midst of plenty” manifested by overproduction and underconsumption. That may just be what is ailing China at the moment, as Chinese consumer spending as a proportion of GDP has been declining for the last half century in China.

Article in October issue of Shopping Centers Today

Next month’s issue of Shopping Centers Today (the house publication of the International Council of Shopping Centers) quotes me among other analysts in an article entitled “Many shiny new malls in Asia are devoid of tenants and shoppers”. Curt Hazlett reports many new but empty luxury malls in both China and India. There are various reasons cited, chiefly lack of experience and market analysis by the actual developers, who are private entrepreneurs.

This misallocation of resources is now being discouraged by the Chinese government. Recently, the Chinese Banking Regulatory Commission has been trying to proactively engineer a soft landing to a real estate bubble through stricter bank regulations. Reckless Chinese developers now find themselves unable to get Chinese bank loans for ill-conceived projects. The People’s Bank of China reports, for instance, that new lending to property developers declined to 42 billion yuan ($6.56 billion USD) in the second quarter of 2011, down 75% from 168 billion yuan in the first quarter. I have also seen similar policies put in place by the elected governments of Singapore and Hong Kong.

Real estate developers the world over are like heroin addicts, constantly seeking financing, and Chinese developers are no exception. If you give enough money to a developer, he will develop, because that is his raison d’etre. Chinese developers have found two alternate sources of funding after the shutting off of the Chinese banking spigot: private trust companies within China, which funnel investments from wealthy individuals and companies, and REITs created on foreign stock exchanges. The Chinese government is now cracking down on trust company lending, too.

So what is currently causing the continued overbuilding of luxury malls in China? In short, it is foreign investment. The “Chinese economic miracle” has been oversold to naïve foreign investors by self-serving capitalists.

This last year has shown that it is easier to finance grandiose Chinese commercial real estate development schemes with equity offerings on foreign exchanges than with Chinese lenders. These equity investors (shareholders) have often been suckered because the "Chinese economic miracle" story has been so compelling and the IPO sponsors have been less than forthright. The logic that Chinese GDP growth is causing equivalent growth in consumer demand is contradicted by actual statistics: Per ISI Emerging Markets Inc., who maintains the CEIC China Premium Database, Chinese consumer spending as a proportion of GDP has now hit an all-time low of 34% and predicted to decline for two more years after being about 45% one decade ago and about 50% two decades ago, not quite the "consumption revolution" crowed about on empty New South China Mall's web site.

Walking through empty retail malls in Dongguan, Beijing and Shenyang, I was struck by the high prices on the merchandise offered. The median household income for Class-1 and Class-2 cities is estimated to be about $5700 per year, about 12% of the U.S. median, which is not conducive to a Gucci lifestyle. (The Chinese national average is about $3300 per year.) Wealthy Chinese, however, have the ability to travel and shop outside the country, where they find lower prices on luxury items, whether in Hong Kong, Singapore, Beverly Hills, or Vancouver. (Hong Kong attracts many Chinese shoppers due to the lack of a sales or value-added tax.) That narrows down the universe who have the resources and desire to buy their luxury goods domestically.

Recruiting foreign investors

Foreign investors may have misconceptions about Chinese shoppers based on the Chinese shoppers who travel to their own countries. These shoppers represent the affluent class of China, which is small in proportion to the total population. Mall investment sponsors have been capitalizing on this misconception.

Foreign investors are easier to take advantage of than Chinese investors due to their lack of legal recourse when they are cheated. Law enforcement can be heavy-handed within China. For instance, while I was staying in Shenzhen, the former mayor had just been convicted of corruption and sentenced to death. Executives of a company committing fraud on the Shenzhen or Shanghai stock exchanges are subject to severe criminal penalties, particularly if they cheat the government. Not so if the company is listed on a foreign exchange, such as Hong Kong, Singapore, New York or Toronto.

From GAAP to CRAAP

Just as U.S. securities laws are not extra-territorial, neither are Chinese securities laws. China does not have GAAP (Generally Accepted Accounting Principles), so the rules governing accounting are different; Chinese accounting policy has been nicknamed CRAAP (Chinese Regularly Accepted Accounting Policy) by hedge fund manager Jim Chanos.

The Chinese economic miracle has been a 30-year growth trajectory that has averaged annual GDP growth of 10% per year (according to the government) and created 115 billionaires as of the last Forbes count. Just remember, though, that the building of empty malls and office buildings is part of that GDP growth.

Chinese consumer spending has failed to keep pace, too, as Chinese household income, is less than 10% of U.S. household income. This is what Marx predicted would happen to capitalist societies, that workers would end up being financially unable to buy the very products they were producing. The empty luxury malls are evidence of that.

Jinbao Place: Arriving Too Late at the Beijing Luxury Party 金寶匯

2011-09-21T18:16:00.000-07:00

Jinbao Street is the ultimate luxury shopping street in Beijing, similar to Rodeo Drive in Beverly Hills. In its two-block stretch there are three 4 or 5-star hotels and Bentley, Ferrari, Maserati and Mercedes dealerships.

A three-year-old, 40,000 square meter (430,000 square foot) luxury mall known as Jinbao Place stands largely vacant on this otherwise busy street. Above the second floor in this seven-stories-above-grade mall, almost all space is vacant. The seventh floor, the restaurant floor, has a roast duck restaurant.

The problem is not the location. Jinbao (translated as “golden treasure”) Street is the best known destination for Beijing’s wealthiest shoppers. The problem is that most luxury retailers are already represented nearby in the Dongcheng district that contains Jinbao Street.

Jinbao Place’s current tenants include Gucci, Omega, Burberry, Canali, Bottega Veneta and Vertu, two restaurants and a coffee stand.

Gucci already has its own stand-alone store 4 blocks west, as does Omega, with its store on the very popular Wangfujing pedestrian shopping street.

Burberry has another store near the Peninsula Hotel just two blocks west as the street name changes from Jinbao to Jinyu Hutong.

Canali has another store at the highly trafficked Oriental Plaza mall (see my blog about the Hui Xian REIT), about six blocks southwest.

This mall was developed and owned by the Fu Hwa International Group, rumored to be a Taiwanese company.

The photos were taken at about 5 pm on a Thursday afternoon.

Cleaning woman, but who is there to clean up after?

A Visit to Perennial China Retail Trust’s Assets in Shenyang, China 鹏瑞利中国零售信托

2011-09-20T22:43:00.000-07:00

Recapping my June blog on Perennial China Retail Trust (PCRT), PCRT was a recent Chinese real estate IPO on the Singapore exchange which hyped itself as the only “pure play on Chinese retail” available to Singaporean investors. It advertised “a total valuation of approximately S$1.1 billion as of December 31, 2010” based on an independent valuation by CB Richard Ellis of its five principal assets, which are two malls and an office complex situated together in Shenyang and malls in Foshan and Chengdu, but the valuation report was based on the false premise that all five properties had been completed and fully leased, when only one building, the Red Star Macalline Furniture Mall, had been completed and opened, and the malls in Foshan and Chengdu had not only not been started, but the land had not yet been acquired by PCRT at that time. In other words, the Foshan and Chengdu malls did not exist, yet they are included in the current market valuation of this trust, as published on page 434 of the Prospectus.

In other words, the valuer had not been independent and had instead abetted the misrepresentations of the IPO sponsor. It should also be noted that the CEO/IPO sponsor receives substantial annual compensation based on the independent valuation rather than the market capitalization of the outstanding shares, which is now less than half the amount of the "independent valuation" report. This is another built-in conflict of interest within PCRT.

I also questioned why the Singapore Exchange would allow PCRT to represent undeveloped properties as being fully developed and leased in their representations to the public of total asset valuation and why there were no controls on the misbehavior of supposedly “independent valuers” who are in reality the paid whores of IPO sponsors.

PCRT initially attempted to go public in February by offering approximately 1.1 billion shares at S$1 per share but received an inadequate response. The offering was re-priced at S70 cents per share in June and was fully subscribed at that time. Since then, the market-traded share price has declined to S40 cents per share as of Octomber 5, 2011. With 1,121,695,000 shares outstanding, this represents a loss to investors of more than S$336 million in market capitalization.

The visit to Shenyang

The location of the Shenyang properties is highly visible and accessible via the First Ring Road, and the Longemont Mall also has its own bus depot and subway rail station. This is a first-rate location.

I was disappointed to find the renamed Red Star Macalline Global Home Furniture Life Mall closed for the day at the time of my arrival at 7:15 pm. I naively assumed that it would be open late like most Chinese malls, but its official closing time is 6:30 pm; the error was mine. The closing time is the same at the other Red Star Macalline store in Shenyang.

The Longemont Shopping Mall is now open and a beautiful sight to behold. The only things lacking are tenants and shoppers and western-style toilets. (Chinese "squat" toilets are simply porcelain holes in the floor. For a purposely western-style mall, this is an incongruity that I just cannot take sitting down.)

Chinese toilet

Ground floor of mall

First floor of atrium

Third floor

To be fair, basement levels B1 and B2 have a hubbub of activity drawn by a major 20,000 square meter (215,000 square foot) supermarket with linkages to the city’s bus and rapid transit systems. Floors 1 through 7 were a different matter entirely, as seen in the other photos. My visit was timed between 7:15 and 8:30 pm on a Friday evening.

Basement supermarket

Many multi-level Asian malls also have their top floor or floors devoted exclusively to restaurants, and this can be one of the busiest sections of a mall in the evening. Not so here. Longemont’s 7th floor is also devoted to restaurants, plus an ice skating rink, but it appears that only half of the restaurant space has been rented out.

Seventh floor restaurant level

While I was dining on shredded dog meat in chili sauce on the 7th floor, I asked an employee why the Red Star Furniture mall was closed so early, and he was surprised to hear that it was already closed for the day, claiming that it was supposed to be open until 9 pm just like the Longemont Mall. “Not many people go there,” he also said. Nevertheless, the signs at Red Star Mall clearly indicate a 6:30 pm closing time.

The recent announcement by construction equipment manufacturer Kohmatsu that it was not getting paid by Chinese developers presents further evidence of financial distress among Chinese developers. This does not bode well for a Furniture Mall. Moreover, the first major Chinese real estate developer default has been Dalian Rightway, based in nearby Dalian, another city in the same province of Liaoning, and the amount of Chinese space that has started construction but has not yet been sold has increased to 850 million square meters (over 9 billion square feet), which is now more than four times the historical average.

Miscount of tenants at Longemont Shopping Mall

Although the PCRT web site advertises Longemont Mall as having 800 tenants, the number of open stores appears to be less than 200.

Is Longemont Shopping Mall "skating on thin ice"?

Two 56-story office towers are still under construction and show progress compared to previous photos from June. Leasing activity is not known yet.

Options on other sites next to future High Speed Chinese Rail Stations are also mentioned in the Prospectus. The July 23rd high speed train crash in Zhejiang that killed 40 and injured almost 200 revealed shoddy standards and official corruption which warranted the the arrest of the former railway minister Liu Zhijun. As a consequence, railway construction is now being delayed, with only one-third of projects still ongoing construction, while many railway construction workers complain about not being paid (more than 2000 alone at the China Railway Engineering Corporation.) What is the consequence for PCRT assets located at future high speed rail locations?

Remember, too, that all 5 properties are situated on ground leases. The Shenyang lease expires in year 2059, while the Foshan and Chengdu leases expire ten years earlier. What will happen then? The Chinese ground lease system only started in 1980, so none have expired yet, and there is no case history to learn from about when valuable malls sit on expiring ground leases.

Investors in PCRT (N9LU on the Singapore exchange) are probably quite disappointed now; those who bought at the offering price of 70 cents have seen a 43% decrease in value since June. $336 million of investor value has been lost since the first day of public trading.

For those who relied on the independent valuation report, I don't know what legal recourse they have in Singapore. As I indicated in my previous blog about the Gibson v. Credit Suisse lawsuit in the U.S., appraisal firm Cushman and Wakefield is facing a $24 billion lawsuit and has failed to achieve dismissal by summary judgment after almost two years even though its valuation reports disclosed that their estimates of value were not meant to represent current "market value". The CBRE report does not make such a disclosure until the Appendix section, and how many investors read that far? Those who are litigious might also know that CBRE has even deeper pockets than Cushman and Wakefield.

One bit of encouraging news is that CEO Pua Seck Guan has finally started buying shares at recent market prices. Why didn't he buy before now?

Disclosures: None. I have no short or long position in this stock.

Appraisal in Tepotzotlan, Mexico

2011-08-17T13:17:00.000-07:00

The story sounded compelling: 26 hectares of flat, residentially zoned land at the northern periphery of the Mexico City metropolitan area, not far from the Autopista, the major north-south highway leading to Mexico City, 42 kilometers south. Next door was said to be a gated subdivision with a golf course. The owners claimed to have had a bank appraisal in 2006 establishing a value of 177 million pesos, equivalent to about $16 million USD at that time.

The idea of the site’s potential for residential subdivision seemed plausible at first. As modern life takes over Mexico City, it has increasingly grown like an American city, with residents fleeing to growing suburbs and the city population actually declining, similar to Chicago, Detroit or Baltimore. The subject property initially sounded like an ideal location for a new housing subdivision.

The paper chase

One of the documents I requested from the landowner was the most recent predial (property tax receipt). I use it to double-check items such as owner, location, tax ID number (clave catastral), and assessed value, which I hope might point me in the right direction of true market value.

I was provided instead with a predial from 1992, indicating an assessed value of 87,696,000 pesos. Why would they do something like that?

At today’s exchange rate of 12.18 pesos to one dollar, the land would have been worth $7,200,000 back then, but that would be in nuevos pesos, which were not established until 1993, after a period of hyperinflation, when Mexico issued the “new peso” to replace and be valued at 1000 old pesos. The exchange rate on the date of the predial would have been 3064 “old” pesos to one dollar, with the assessed value being equivalent to only $28,621 USD!

Thus, the purpose of providing a predial dated prior to 1993 was an attempt to confuse me. The alleged bank appraisal from 2006 never materialized, either.

The property inspection

After exiting from the Autopista, we traveled another half hour on roads that progressively got narrower and rougher, making numerous turns as we traveled through residential neighborhoods with speed bumps on every block. The paved roads then ended and we traveled on narrow, rutted dirt roads.

Arriving at the site, I found it to be a hillside. The elevation dropped by 150 feet from top to bottom.

Immediately west was a neighborhood of makeshift shacks and dirt roads.

Immediately south was a neighborhood of modest, concrete block structures on small lots, served by paved roads. Graffiti was prevalent.

Immediately north was the countryside. Immediately east was the gated subdivision I had heard about.

Neighboring gated community

After walking about the subject property, we drove to the gated community next door to perhaps give me some idea of the residential development potential of the subject site.

The guardhouse was closed. One of the four gates was open to traffic, however. Once inside, I saw mostly vacant lots, a few structures, some which appeared to be vacant, and no golf course. Census data indicated that only 18 households live in this subdivision. The developer is still advertising to build attractive new 3-bedroom homes of 2500 to 2600 square feet for 1.2 million pesos unfurnished or 1.5 million pesos furnished, equivalent to about $98,000 and $123,000.

Comparable properties

Sales of large parcels were not to be found, so I turned to listings. The most similar property in terms of size and proximity was in the next town west, but its H500A (municipality of Tepotzotlan) zoning allowed 5 times as much residential density as the subject site – 20 dwellings per hectare or 8 dwellings per acre. Its listing price translated to about $72,000 per hectare, for five times the allowable density. Other local parcels were priced as low as $20,000 per hectare (although that one was in a more remote location).

It soon became apparent that the appraised value was going to fall far short of the $16 million that the lender was led to believe. Moreover, this particular lender’s minimum loan size is $1 million with a maximum loan-to-value ratio of 50% for raw land, so there was no real possibility of getting a deal done here.

Costa Rican Teak Farms for Gringo Investors

2011-08-07T13:59:00.000-07:00

I’ve been preparing for an upcoming tree farm appraisal assignment in Costa Rica, but learned late that what was thought to be a teak farm is actually a tree farm with lesser tree species. Nevertheless, something should be said about the teak farm market in Costa Rica.

In the late 1980s Costa Rican President Oscar Arias declared a state of emergency concerning the depletion of the nation’s forests, much of which had been felled for timber harvesting or cattle ranching. Generous tax exemptions were put in place to encourage commercial reforestation projects. Capitalism quickly and enthusiastically addressed the problem, and some of those who observed the flow of international capital into Costa Rican forestry investments figured out that perhaps there was more money to be made by selling forestry investments than in actually growing, harvesting and processing the trees.

As with any market for investment properties, distortions are created when properties are developed in response to investor demand rather than consumer demand. For instance, great surpluses of “rental homes” were developed in Phoenix, Las Vegas and Kissimmee, Florida, not in response to a shortage of housing in those areas, but to sell to out-of-state investors. Costa Rican tree farms are now repeating the same concept all over again.

Teak became the preferred tree farm crop because of its high value. There were no restrictions on the creation of new supply in Costa Rica, so many entrepreneurs got into the teak plantation business and European “investment funds” (syndications) were organized to develop teak plantations for small investors. Many teak plantations were subdivided into smaller parcels for purchase by small, absentee investors in North America and Europe.

Misleading data crowding out objective data

The Costa Rican timber market is fragmented and lacking in price information, which has led to the crowding out of objective information by hyperbole crafted by investment promoters, many of who claim historical investment returns in the timber industry of greater than 13% per year. This is not based on Costa Rican data, however.

The most recent price survey among the Costa Rican members of OLAT (the Latin American Teak Organization) indicates prices between $120 and $595 per cubic meter for standing teak trees, depending upon diameter, but prices appear to have decreased since February of this year. For instance, standing teak trees of 50 to 59 centimeters in circumference were priced at an average of $220 per cubic meter then but are now priced at $175 per cubic meter, a drop of 20% in the last six months. Mature trees above 30 years in age have much greater value per cubic meter than immature (“short rotation”) trees, as they can be more efficiently processed into large pieces of sawn wood.

Investment promoters, however, are misleading investors with pro forma cash flow projections based on price increases of 5 to 10% per year, despite the increasing supply of Costa Rican teak, and shortened maturity times of 20 to 25 years. OLAT’s data is based on reported prices for mature 30-to-50-year-old trees (the older, the more valuable) and describes 20 to 25-year old plantations as “young plantations” for which there is insufficient market price data, and also commenting that “Latin America will supply an important part of the teak market, but is not properly geared to marketing short rotation material. This will change in the coming years, with the knowledge that producers are not getting the best price, the market being controlled by buyers.” In Asia, teak trees are often not harvested until 60 years.

As for the balance between teak supply and demand in Costa Rica, OLAT states “With all the money that was invested by forestry funds over the years in Latin America many plantations were enthusiastically created and the know-how has been improving steadily. Lacking, to some extent, are the sales aspects of plantation products.”

Investment Promoters and Scam Artists

Some investment promoters are not even selling land to investors, just the trees themselves. It is important to know that titled ownership in Costa Rica extends to real estate only; there are no tree titles, and the idea of tree titles in a nation with so many more trees than people would be an administrative nightmare, even if it was tried. Any contract in English guaranteeing rights to tree ownership may not be valid or enforceable in Costa Rican courts, either. How does one prove ownership of trees that are situated on someone else’s land?

Many investors claim to be victims of scams in which plantation owners sell tree ownership and then charge a fee to manage the tree investment; Tropical American Tree Farms seems to have attracted the most complaints. Most of the alleged fraudsters are gringos themselves, including Eric Heckler, who was a fugitive from mortgage fraud charges in Florida when found selling teak trees that weren't his before being extradited back to the U.S. in 2009.

In the numerous listings of teak plantations for sale in Costa Rica, a sizeable discount per tree is apparent for the larger plantations, indicating an insufficient demand for the quantities of teak they are producing, with prices as low as $167 per standing tree for 20-year-old trees, which translates to about $244 per cubic meter (based on an average of .8639 cubic meters per 20-year-old teak tree), quite a bit lower than even the OLAT-published prices.

Next stop: Tepotzotlan, Mexico

Why Fraud is Attracted to International Real Estate Transactions

2011-08-01T11:56:00.000-07:00

Several of my previous blogs refer to the possibility of fraud in international real estate transactions. It stands to reason that a property owner or developer who cannot find buyers or financiers in his own country will seek them out in other countries, perhaps taking advantage of the foreigners' lack of local knowledge. Why, for instance, must Spanish hotels be marketed in the U.S.? Could they not attract European investors?

I do not wish to seem overly critical of Chinese or Central American property owners. A predilection to commit fraud is a fault of human nature and knows no nationality or ethnicity, as I’ve seen plenty of it in the U.S. Fraud tends to flow to those areas where:

1. The controls are weakest,
2. The opacity is greatest,
3. The penalties for fraud are the least severe or least likely to be enforced, and
4. The story sounds the most sensational.

Let me provide an example:

Imagine a nation which has experienced average annual economic growth of 5% after inflation for the last 14 years and real estate prices are rapidly increasing [the story]. Real estate transaction prices are not disclosed due to privacy concerns [opacity]. The culture is very pro-business and real estate regulation is non-existent except for the licensing of real estate sales agents [weak controls]. Prosecution against white collar fraud is unheard of [lack of penalties and enforcement].

Are you ready to invest?

Well, you’re too late, because the place I just described was my home state of Texas in the year 1985. What happened next was an economic disaster. Much of the Texas economic miracle had been based on real estate construction, adding far more supply than could be absorbed at even robust growth levels. Any new development could get 100% financing from a Texas bank, and developers were allowed to order their own valuations from their favorite appraisers. As new buildings stood empty, bank loans could not be repaid. Property prices plummeted. Almost every Texas-domiciled bank and thrift institution failed. Construction workers, realtors, appraisers and bankers lost their livelihoods. The unemployment rate was 12% in Houston when I lost my job there and moved to Los Angeles in 1987.

From 1984 to 1987 I was working in the Houston office of Jones Lang Wootton. My colleagues were busy acquiring and managing investment properties for British, German and Saudi investors who were excited by the Texas story. This all changed rather quickly.

Travel ahead 25 years in time and is China or Costa Rica that much different?

The Rights of Foreign Victims of U.S. Real Estate or Mortgage-Backed Securities Scams

2011-07-27T14:29:00.000-07:00

A few previous blogs touched on the subject of real estate fraud that crosses national boundaries, and how difficult it can be for American victims to seek redress in foreign courts. I might have sounded xenophobic by focusing on scammers in Latin America, Canada and China, but international real estate fraud works both ways. There are also foreign victims of U.S.-based frauds.

Ethical standards in the U.S. should not be considered different from ethical standards elsewhere. It is not the nationality that matters, but the type of people the real estate industry attracts – people who want to make lots of money. If the real estate industry instead attracted saints, perhaps Mother Theresa herself would have devoted her life to selling condos to foreigners.

Prestige and fame matter little, too, in protection from fraud, as this blog will focus on extensive litigation against Goldman Sachs, an institution once so hallowed that our last three U.S. presidents have selected Goldman executives to become U.S. Secretary of the Treasury, including the present one.

U.S. Securities Laws are not Extra-Territorial

An overseas investor might also be surprised to find that U.S. securities laws do not apply to U.S. real estate investment securities marketed overseas, which includes mortgage-backed securities and real estate syndications.

For instance, Australian hedge fund Basis Yield Alpha recently lost its lawsuit against Goldman Sachs for a $78 million loss on its investment in a Goldman-sponsored CDO (collateralized debt obligation) known as Timberwolf 2007-1, which specialized in subprime mortgage loans. Goldman profited by betting against this CDO, as they have been known to do, even letting John Paulson design another CDO in which he was able to pick the nonprime packages that were “most likely to fail” and then invest in credit default swaps. The U.S. Securities and Exchange Commission sued Goldman and settled for $550 million one year ago this month.

Goldman, for this reason, faces other investor lawsuits from domestic investors, but Judge Barbara Jones dismissed the Australian lawsuit solely because U.S. securities law only governs securities sold within the United States. (As you may recall, This jurisdictional exception was upheld by the U.S. Supreme Court last year in the landmark case, Morrison v. National Australia Bank Ltd. This decision serves to bar the extraterritorial application of the U.S. Securities Exchange Act of 1934. In that case, although the lead plaintiff, Morrison, was American, the remaining plaintiffs were Australian and were victims of NAB’s (National Australia Bank) inaccurate accounting for its American mortgage servicing subsidiary, HomeSide Lending. The plaintiffs argued that the overvaluation of mortgage assets occurred in Florida, where the subsidiary was located, and U.S. securities laws should therefore apply, but the Court found that the securities were sold in Australia, by Australians, to Australians, and therefore U.S. law did not apply. Morrison, the American, could not prove damages, either.

Korean insurer Heunkuk Life Insurance is similarly affected in its lawsuit against Goldman Sachs.

These recent Federal court decisions do not preclude plaintiffs from suing in state courts or foreign courts.

GIC's Failed New York Real Estate Investment: An In-Depth Analysis

2011-07-20T00:31:00.000-07:00

Peter Cooper Village. Isn't it beautiful?

While recently in Singapore, I encountered lively debate about Singapore’s two sovereign wealth funds, the Government of Singapore Investment Corporation (known as “GIC”) and Temasek Holdings. Given Singapore’s reputation for clean government, some citizens grumbled about the lack of transparency with which these funds operate. I first became curious about GIC last year after learning of their $675 million + loss in the default of a New York apartment community known as Stuyvesant Town/Peter Cooper Village at the beginning of 2010. Doing research on GIC I quickly came to a dead end, unable to determine their holdings.

The failure of Stuyvesant Town/Peter Cooper Village at the beginning of 2010 resulted in the largest real estate foreclosure [actually “deed in lieu of foreclosure”] in U.S. history. These two aging apartment communities, with a total of 11,250 apartments, were together purchased for $5.4 billion in 2006 in a syndication organized by Tishman Speyer and BlackRock; there was also $4.4 billion in first and mezzanine financing. The purchase price equated to $480,000 per apartment in two complexes that were built in the 1940s, equating to an annual gross rent multiplier of more than 30, unheard of for an American apartment property not headed for condo conversion (but perhaps common in Singapore).

73% of the apartments had rents restricted by New York’s Rent Stabilization Ordinance, and the average rent for a one-bedroom apartment was about $1300 per month at the time. At the time of purchase, market rents on one-bedroom apartments, once renovated, were estimated to be $3200 to $3500 per unit.

The loans were underwritten not according to present income but according to pro forma income expected in 2011, five years hence. Net operating income was forecasted to triple in five years! Tishman reportedly planned to more actively manage the property than previous owner MetLife, and thought rents could be raised through renovation and the eviction of or renegotiation with illegal tenants, estimated to occupy about 1000 units. MetLife previously also had a plan to convert the units into luxury apartments, but found itself legally confounded by tenant litigation. They basically tried the same strategy before and failed.

Enterprising New Yorkers sometimes pretend to keep possession of apartments with restricted rents while subletting to other unrelated parties. Tishman planned to aggressively raise rents on these illegal subletters. One problem, though, was that under the Rent Stabilization Ordinance, stabilized rents below $2000 per month are not eligible to be raised to market value, and most of the units were earning less than $2000 per month.

My personal observation is that New York is a very litigious city (I had an appraisal office there in the 1990s). I have been threatened with lawsuits just for calling up buyers or sellers and asking them what they paid for their properties. MetLife had already been stymied by tenant lawsuits, so Tishman should not have been surprised that its aggressive rental increase program would also attract a class action lawsuit on more than 4000 units. The courts judged $200 million in rental increases to be illegal and awarded $4000 to each renter.

Besides ruinous legal expenses, the financial industry meltdown had hit the New York apartment rental market hard, and market rents were falling. Asking rents on one bedroom apartments at Stuyvesant/Cooper had declined to $2255 per month at the time of foreclosure, not including a $500 move-in bonus.

The first mortgage loan was underwritten at a 1.7 debt coverage ratio based on pro forma Year 2011 NOI, but actual first year debt coverage in year 2006 was only .48! Having worked for America's largest multifamily lender in the 1990s, a deal like this would never have been done. Including the mezzanine debt, the 2011 DCR would have been only 1.2. Even more surprising was that there were two pieces of mezzanine debt, and GIC held the subordinate piece, $575 billion, which became worthless at the time of foreclosure. The superior mezzanine lien at least received $45 million.

What this meant for equity investors was years of red ink before the property could earn positive cash flow. When the projections became unattainable, there was no more reason for the investors to hold on to the properties, and the lenders took possession.

The most recent appraisal of this complex estimated market value at about $2.8 billion, meaning a potential loss of about $2.6 billion for the consortium of lenders which include Wachovia (now Wells Fargo), Merrill Lynch (now Bank of America), GIC and the other mezzanine lender.

The Beijing Gateway Plaza fraud controversy

2011-07-08T10:07:00.000-07:00

Almost any real estate valuation report in the world has the same “limiting condition” buried within the report which reads more or less as follows:

“We have relied to a very considerable extent on the information provided by the owners and have accepted their representations of tenancy, occupancy, financial performance, site area and floor area, which we assume to be true and accurate. We take no responsibility for inaccurate client-supplied data and subsequent conclusions related to such data.”

What if the property owner lied, though? Then, the accuracy of the valuation is compromised. This is a problem the world over, particularly when the property owner is the one who hired the valuer.

This week’s lawsuit by Tin Lik, a Hong Kong developer, against the trustees of the RREEF China Commercial Trust is an interesting example of the consequences of misrepresentations. This lawsuit came immediately after the June 30th judgment against Tin Lik in the case of HSBC Institutional Trust Services v. Tin Lik, decided by The High Court of the Hong Kong Special Administrative Region.

HSBC Institutional Trust Services was the trustee of the RREEF China Commercial Trust, a Hong Kong REIT having the Beijing Gateway Plaza office complex as its sole asset. On June 4th, 2007 the Trust bought Gateway Plaza from Tin Lik based on Tin Lik’s representations of rental income, representations which were discovered to be false by the newly appointed REIT manager, RREEF China REIT Management Limited, who then calculated the financial value of the discrepancies to be HK$278,526,708. These discrepancies and the estimation of financial loss were later reviewed and confirmed by an independent subcommittee which included an un-named international accounting firm.

On September 7, 2007, Tin Lik agreed to pay the full sum of HK$278,526,708 and promised to make further payments if that sum was later found to be insufficient. Such an action is tantamount to a guilty plea.

A new valuation of the property was done on September 30, 2007, establishing a value of HK$3,699,000,000. After taking into consideration the HK$278 million already paid by Tin Lik, the Net Asset Value attributable to all the unit holders was still HK$69,663,000 lower than if the rents had never been represented.

The Sale and Purchase Agreement by which the Trust acquired Beijing Gateway from Tin Lik established monetary “set-offs” for other discrepancies as well, such as breach of warranties. Tin Lik had warranted certain equipment such as lifts (elevators) and HVAC as being in good repair and reasonable working order, having been regularly and properly maintained and not dangerous or obsolete, but some of the equipment had to be repaired or replaced.

There was also a guarantee of billboard rental income of RMB35 million for the first year, 38 million for the second year, and 40 million for the third year, but the tenant defaulted.

Based on the breach of warranties, the REIT manager calculated further “set-offs” due from Tin Lik as being:

HK $216,890,160 in 2007
HK $ 35,270,591 in 2008
HK $ 11,533,376 in 2009 and
HK $ 12,902,544 in 2010, which adds up to HK$276,596,671 additionally due to the Trust from Tin Lik.

Tin Lik disputed the set-offs and on May 20, 2010, sent a letter demanding repayment of the HK$287,497,000 he paid on September 7, 2007 to settle discrepancies related to rental income. Unfortunately, the property was sold to Mapletree India China Fund on February 3, 2010, and after the sale, a Special Resolution of the unitholders was passed on March 31, 2010 to terminate the Trust and delist it from the Hong Kong Stock Exchange.

Tin Lik is now contending that he was coerced into admitting fraud and making the HK$287,497,000 payment to the Trustees in his new lawsuit, which seeks to recover that payment.

"Independent Valuation" Problems in Chinese Equity Offerings

2011-07-04T22:59:00.000-07:00

One notable scandal this last month was the public accusation that Sino-Forest, a Chinese forestry resources company traded on the Toronto Exchange (TRE.TO), is no more than a Ponzi scheme. The accusation was made by Hong Kong equity research firm Muddy Waters, LLC, in a 40-page research report reminiscent of Harry Markopolos’s expose of the Madoff Ponzi scheme.

I will not comment on the merits of the accusation other than to say that there is enough fraud coming out of China that I don’t see a reason for an analyst to make up false stories. On U.S. exchanges alone, eleven Chinese companies have had their securities registrations revoked by the SEC (Securities and Exchange Commission) and 24 more have been forced to address accounting irregularities or auditor resignations, and of the 19 most recent filings of class action securities lawsuits in the U.S., at least 5 have been against Chinese companies. The simple observation that Sino-Forest has produced no free cash flow or dividends in 16 years in spite of escalating revenues is cause for suspicion. John Paulson dumped his shares right away after the MW report.

Some of you may wonder about the CFE initials in my by-line. They stand for "Certified Fraud Examiner", a credential awarded by the Association of Certified Fraud Examiners. One thing we were taught in our educational program is that fraud is a crime of opportunity. It will move to areas where the controls are weakest, opacity is greatest, and greed and a miraculous story get in the way of due diligence and reason. This makes China an ideal place to commit fraud, just as Florida and Las Vegas were 5 years ago.

Foreign investors are wowed by China's reported 10% annual GDP growth rate and accept Chinese financial reporting with the assumption that auditors and valuers know everything going on within a Chinese company. Many Chinese companies create a labyrinth of offshore entities in the British Virgin Islands and Cayman Islands to hide transactions or owners from view. Sino-Forest and Hui Xian have both done that.

As for Sino-Forest, Muddy Waters specifically addressed the reliability of the "independent valuation" report, as follows:

"TRE provides fraudulent data to Poyry, which
produces reports that do nothing to ensure that TRE is
legitimate."

and

"TRE became more sophisticated – engaging Jakko Poyry to write valuation reports, all the while giving Poyry manipulated data and restricting its scope of work. Thus more and more investors are drawn into TRE’s fraud every year as it falsifies timber investments and manipulates Poyry further."

One common theme of the Muddy Waters analysis and my own blogs about Perennial China Retail Trust and Hui Xian REIT is the use and abuse of so-called “independent valuation reports” from respected firms with valuers possessing respected credentials. In each case, the sponsors that hired the valuers restricted the scope of work or imposed assignment conditions which impaired the reliability of the reports. Each example is explained as follows:

Independent valuation of Sino-Forest (TRE.TO)

As Muddy Waters describes, the independent valuation firm Jaakko Poyry couched its valuation opinion with multiple disclaimers such as follows:

• “Poyry has not viewed any of the contracts relating to forest land-use rights, cutting rights, or forest asset purchases.”

• “It is important to understand that this is not a confirmation of forest ownership, but rather a verification of the mapped and recorded areas of stocker forest.”

These types of disclaimers naturally arouse suspicion, as in Shakespeare’s famous phrase, “The lady doth protest too much, methinks.” Why would the valuer feel the need to make such statements unless he knew something was wrong?

Independent valuation of Perennial China Retail Trust (N9LU.SI)

Here’s a situation in which the annual base fee to the Sponsor is established by independent valuation, but the “independent valuer” was asked to assume that all five properties had been acquired and developed and leased to full occupancy, when only one of five properties had been and two only existed as purchase options. The obviously inflated appraised value of about $1.1 billion SGD is >54% above market capitalization at the close of markets on July 4th. The $1.1 billion SGD appraised value translates to an annual base fee of $3,850,000.

The valuation firm, CB Richard Ellis, also performed limited due diligence, as they explained as follows in the valuation report that was included in the IPO prospectus:

“Whilst CB Richard Ellis has endeavoured to assure the accuracy of the factual information, it has not independently verified all information provided by the Trustee-Manager (primarily copies of leases and financial information with respect to the Properties as well as reports by independent consultants engaged by the Trustee-Manager).

CB Richard Ellis has relied upon property data supplied by the Trustee-Manager which we assume to be true and accurate. CB Richard Ellis takes no responsibility for inaccurate client supplied data and subsequent conclusions related to such data.

This confidential document is for the sole use of persons directly provided with it by CB Richard Ellis (Pte) Ltd. Use by, or reliance upon this document by anyone other than Perennial China Retail Trust Management Pte. Ltd. (as Trustee-Manager of Perennial China Retail Trust) is not authorised by CB Richard Ellis and CB Richard Ellis is not liable for any loss arising from such unauthorised use or reliance. This document should not be reproduced without our prior written authority.”

Independent valuation of Beijing Oriental Plaza (Hui Xian REIT)

The owners had been receiving valuations of its only property, Beijing Oriental Plaza, from DTZ Debenham Tie Leung Limited on an annual basis. The valuation was RMB 11.2 billion at the end of 2009 and RMB 20 billion as of October 31, 2010, based on a decline in market capitalization rates and an increase in rents of 2% for offices and 6.7% for retail tenants.

Nevertheless, for the purposes of the IPO and the estimation of a “revaluation surplus” distribution to the previous owners, a different valuer was chosen – American Appraisal China Limited -- who estimated market value to be RMB31.4 billion as of January 31, 2011, just three months after the DTZ valuation of RMB 20 billion, a further increase in value of 57%. Despite this new valuation, though, the IPO sponsors priced the entire offering at between RMB 26.2 billion and 27.9 billion, 11 to 17% below appraised value. Why would the Sponsors price below appraised value unless they didn’t believe the appraised value of AAC? Why did they switch valuation firms? As of July 5th, market capitalization has dropped to RMB 23.45 billion, which is only 75% of appraised value.

More specific concerns about the valuation report are presented in my Hui Xian blog.

The appraised value of RMB 31.4 billion was used to establish a “revaluation surplus” of RMB 7.775 billion payable to the previous owners, although the market capitalization of the entire REIT was never that high, and current market capitalization suggests that no such surplus value exists. The amount of “revaluation surplus” was based on subtracting net book value of RMB 23.635 billion from the appraised value of RMB 31.41 billion, but current market capitalization of RMB 23.45 billion suggests that no revaluation surplus is warranted, and that the RMB 7.775 billion is money that has been taken from investors through a dishonest scheme.

The new valuers also performed limited due diligence, as they explained as follows:

“We have not carried out on-site measurements to verify the areas of the Property and assume the areas contained in the documents provided to us are correct. We have no reason to doubt the truth and accuracy of the information as provided to us by BOP and Commerce and Finance Law Offices on PRC law. We have also been advised by BOP that no material facts have been omitted from the information so supplied. We consider we have been provided with sufficient information to reach an informed view.”

Conclusion

Allowing IPO and subsequent offering sponsors to order “independent valuations” is a blatant conflict of interest, although this is a problem that is not unique to China. Moreover, an "independent valuation" that refuses or is not permitted to perform verification of factual information, such as ownership, financial operations, or property size, is useless and misleading to investors.

Investors should understand that valuers typically put disclaimers and limiting conditions in their valuation reports to prevent liability for passing on fraudulent data. They basically assume that everything the property owner states is true. This does nothing to ensure that valuers rely on accurate data, but deceives investors into thinking that the valuation reports are thorough and accurate.

Disclosure: I do not have any short or long positions in these stocks.

WORLD CASINO GAMING REVENUE COMPARISON

2011-06-28T17:30:00.000-07:00

Singapore's Marina Bay Sands Casino and Hotel

This website is powered by Google Blogger, and one the most interesting features of Blogger is its tally of the search terms used in finding my International Appraiser blog. My blog on Macau has been attracting those who are searching for statistics on which are the top world gaming destinations by revenue. This particular blog will try to answer that question.

Here is my attempted ranking of world gaming destinations by year 2010 revenues:

1. Macau. $23.543 billion, up 58% from 2009, now exceeding $3 billion/month.
2. Las Vegas/Clark County, Nevada. $7.72 billion (entire county), down 20% since 2006.
3. Singapore. $5.1 billion, first year.
4. Atlantic City. $3.565 billion, down 32% since 2006.
5. Southeastern Connecticut (including Foxwoods, largest U.S. casino). $1.385 billion, up 12% from 2009.
6. Biloxi, Mississippi. $1.106 billion, down 15% since 2007.

This list focuses on singular destinations with an agglomeration of casinos in close proximity rather than countries or states where casinos are geographically dispersed such as France, Pennsylvania, Indiana or the Dominican Republic.

The one trend that is obvious from this list is the explosive increase in gaming in Asia and the decline in gaming in the leading U.S. destinations.

The U.S. gaming market has become increasingly fragmented, with Indian casinos in California and Nevada taking customers away from Nevada’s traditional gaming destinations of Las Vegas, Reno and Laughlin, and Pennsylvania and New York taking customers away from Atlantic City. There are now 19 U.S. states that allow casino gambling, and increasing state budget pressures may tempt more to legalize casino gambling in order to augment revenue.

One important difference in making comparisons between Las Vegas and Asia is that Las Vegas earns more from lodging, food and beverages than from gaming revenues, as most visitors to Las Vegas need to stay overnight because of its distance and isolation from the places the visitors come from; long haul visitors stay longer than short haul visitors, and Las Vegas attracts more long haul visitors. For instance, although the Las Vegas Strip earned $5.167 billion in gaming revenues last year, it also earned $3.106 billion in lodging revenues and $2.923 billion in food and beverage revenues. On the other hand, many visitors to Macau and Atlantic City are on day trips from Hong Kong or Guandong Province (in the case of Macau) and New York or Philadelphia (in the case of Atlantic City).

Gibson v. Credit Suisse: The Mother of All Syndication Frauds?

2011-06-25T23:20:00.000-07:00

Previous blogs have discussed deceptive real estate syndications as well as deceptive Chinese real estate trust IPOs. One common element is motive; the main reason to sponsor a syndication or IPO is to financially benefit the sponsor. If the real estate venture goes well, maybe the investors can profit, too, but the sponsors will surely profit in any event.

The mother of all alleged syndication frauds is the Credit Suisse loan syndication program involving 14 U.S. resorts. A syndicated loan is a loan sold off to multiple investors. I became obliquely involved when I appraised the property of one of the resort developers as additional loan collateral. (I have no relationship with Credit Suisse or Cushman & Wakefield.)

The alleged loan fraud is described by Bankruptcy Court Judge Ralph Kirschner as follows:

“In 2005, Credit Suisse was offering a new product for sale. It was offering the owners [developers] of luxury second-home developments the opportunity to take their profits up front by mortgaging their development projects to the hilt. Credit Suisse would loan the money on a non-recourse basis, earn a substantial fee, and sell off most of the credit to loan participants. The development owners would take most of the money out as a profit dividend, leaving their developments saddled with enormous debt. Credit Suisse and the development owners would benefit, while their developments—and especially the creditors of their developments—bore all the risk of loss. This newly developed syndicated loan product enriched Credit Suisse, its employees and more than one luxury development owner, but it left the developments too thinly capitalized to survive. Numerous entities that received Credit Suisse’s syndicated loan product have failed financially, including Tamarack Resort, Promontory, Lake Las Vegas, Turtle Bay and Ginn [Sur Mer].”

What makes this alleged fraud interesting to International Appraiser is that Credit Suisse is Switzerland’s second largest bank, who allegedly created a fake Cayman Islands branch in order to get around U.S. banking laws, particularly FIRREA (Financial Institution Reform, Recovery and Enforcement Act of 1989).

Credit Suisse and Cushman & Wakefield Appraisal are currently co-defendants in a $24 billion lawsuit filed in Idaho by aggrieved property owners from four of the 14 resorts. The plaintiffs contend that CS saddled the resorts with debts much higher than the underlying real estate values, thereby forcing bankruptcies that impaired the value of the real estate holdings of the individual residents. Such a loan is sometimes called a “predatory loan” and the scheme sometimes called “loan to own”.
As a former banker, I find such a complaint to be hard to believe. Foreclosures are rarely profitable for banks.

Credit Suisse hired the appraisal firm Cushman & Wakefield to appraise each resort according to an unorthodox methodology named “Total Net Value,” which basically ignored the time value of money in estimating the present value of each of these resort developments. Such developments were going to take years to sell out, but future revenues were not discounted for time. The “total net value” (TNV) methodology merely subtracted the costs of development without respect to the timing of revenues. It was tantamount to creating discounted cash flow models with 0% discount rates. Its sole purpose seemed to be to inflate the appraised value and thus justify a higher loan amount.

The appraisal firm performed the appraisals according the Total Net Value methodology dictated to them by the lender and attempted to cover themselves with all the necessary disclosures and Assumptions and Limiting Conditions in their reports. Others mistakenly thought that the appraisals were market value appraisals, and it appears that CS wanted to create that illusion. Cushman even mailed the appraisal reports to the Cayman Islands address, ostensibly to circumvent U.S. appraisal laws.

All 14 syndicated loans failed and property owners at four failed resorts, Yellowstone Club, Tamarack Club in Idaho, Lake Las Vegas, and Ginn Sur Mer in the Bahamas, filed suit against CS and the appraisal firm, claiming that CS had defrauded them with a predatory “loan to own” scheme, that appraisers had used the total net value methodology to create misleading and deceptive appraisal reports that violate FIRREA, and that the defendants, knowing this, engaged in a conspiracy to circumvent FIRREA by creating a special purpose lending entity in the Cayman Islands and having the appraisal reports delivered there. The CS Cayman branch was alleged to be a post office box.

In its motion to dismiss, the appraisal firm claimed that the plaintiffs were aware that the appraisal reports properly disclosed that they were not based on market value. They also pointed out that there was no connection between the plaintiffs and the appraisers and thus no basis for privity (fiduciary responsibility). The motion to dismiss, interestingly enough, also states that the appraisals’ non-compliance with U.S. banking laws was irrelevant to any of the loans because the lender was from the Cayman Islands. How convenient.

The Yellowstone Club example illustrates the magnitude of appraised value inflation as a result of the TNV methodology. Yellowstone Club is a private vacation home community in Montana that includes such notable residents as Bill Gates, Dan Quayle, and Greg LeMond. Prior to CS’s involvement, the same appraisal firm had appraised Yellowstone Club for $420 million. CS instructed the appraisers to revalue Yellowstone Club several months later using “total net value” methodology, and the appraised value shot up to $1,165,000,000, supporting a $375 million loan decision by Credit Suisse. The loan later went into default and foreclosure.

On July 17th, 2009, the foreclosed Yellowstone Club was sold for $115 million to Cross Harbor Capital Partners. The loan loss was therefore about $260 million.

Lessons to be learned

From the standpoint of international investors, there should be the fundamental realization that appraisal or valuation reports ordered by a syndication or IPO sponsor are not “independent valuation reports”, as they are often labeled. Allowing IPO or syndication sponsors to buy and pay for valuation reports is just placing foxes in charge of the hen house.

The U.S. certainly has laws against appraiser misconduct, but enforcement is rare, and was certainly not enough to prevent the greatest global financial crisis since the 1930s, which was due in large part to massive mortgage fraud enabled by appraisal fraud. What’s worse is that most other countries do not even have laws as strict as the U.S., which implemented tougher laws after the Savings and Loan Crisis of the 1980s.

Some appraisers may think that certain liberties can be taken in an appraisal report as long as they are disclosed in the report. Appraisers may agree among themselves on what these types of disclosures are, but those outside the appraisal profession may not understand disclosures when they see them. This particular case may test the limits of how far this possibly undue reliance on disclaimers can go.

The appraisal reports for CS were previously published on the Internet and contained standard disclosures, disclaimers and Assumptions and Limiting Conditions. The “intended use” was for loan underwriting and the “intended user” was CS. An appraiser reading these reports could reasonably infer that the appraised values were not labeled as or intended to represent market values. The plaintiffs in this case would not normally be considered to have a claim based on privity [duty of care to the plaintiff], either. Nevertheless, the appraisal firm is still facing a $24 billion lawsuit after an unsuccessful motion to dismiss.

The current judge on the case has raised the question of whether the plaintiffs properly understood the reports or had such capability. This raises the questions of whether disclosures and Assumptions and Limiting Conditions are enough to prevent the public from being misled. Appraisers should consider that any number printed as “appraised value” is likely to be interpreted by others as an expression of market value. There are many persons, particularly investors, who may rely on an “appraised value” without reading the report and finding the disclosures. Some properties or projects are even marketed with representations of appraised value without ever allowing the public to see the supporting appraisal reports, as was the case with Credit Suisse.

Large firms, in this case an international brokerage and appraisal firm, have deep pockets that can serve as a target for lawsuits. It would be in such a firm’s best interest to avoid all situations allowing accusations of impropriety. In this case, the reason for the using Total Net Value methodology instead of market value was not explained, making it seem that TNV’s sole purpose was to inflate the appraised value. This may make the appraisers seem complicit in the alleged loan fraud by CS, which the appraisals enabled. It is questionable if the appraisers expected to be part of a syndicated loan fraud scheme, though, as the only benefit to them were the fees earned for the reports. Nevertheless, whistleblower Michael Miller at C&W has come forward with allegations and incriminating e-mail messages (such as “not in jail yet and continuing to write these appraisals”) indicating that his colleagues knew they were creating misleading reports.

Congratulations to Cushman are in order for their award of a large "Financial Advisory Valuation Services" contract by the FDIC. Who says that excellence does not go unrewarded?

Final suggestion

Here is a suggestion for investors: Order your own appraisal or at least hire an appraiser to review the “independent valuation.” American Property Research provides such a service.

Hui Xian REIT IPO / Beijing Oriental Plaza 汇贤产业信托

2011-06-19T12:05:00.000-07:00

My last blog about Perennial China Retail Trust presented an example of a Chinese real estate IPO designed to enrich the sponsor rather than investors. Another recent, self-serving IPO focused on Chinese real estate is Hui Xian Real Estate Investment Trust, which is focused exclusively on Bejing’s landmark Oriental Plaza. Oriental Plaza is a 787,059 square meter (8.5 million square feet) mixed-use complex in the Dongcheng district west of the Beijing CBD. Oriental Plaza is partly owned by billionaire Li Ka-Shing, Hong Kong’s wealthiest man and no. 11 on the Forbes billionaires list. His organization is known as Cheung Kong Holdings.

Much as Warren Buffett holds “sage” status in the U.S., Li Ka-Shing holds “Superman” status in Hong Kong, bringing instant credibility to his IPOs. An investor has to first ask, though, what the reason for the IPO may be. The property is already acquired and has performed very well to this date. Mr. Li is not adding to his stake in Hui Xian. If anything, he is lessening his stake, as the use of the proceeds is to reduce bank debt and intracompany indebtedness (to Hui Xian Cayman, a wholly owned subsidiary of Hui Xian Holdings, which is 33.4% owned by Cheung Kong Holdings), which not coincidentally reduces the debt levels and increases the net asset value of Cheung Kong Holdings.

Better yet, going public has also allowed the owners to be paid a "pre-listing distribution" of the "revaluation surplus" of RMB 7.3 billion (>$1 billion USD) due to the property being valued at RMB 31,410,000,000, even though the IPO priced Oriental Plaza at RMB 26.2 billion to 27.9 billion (why so low if the property is really worth 31.4 billion yuan?). Moreover, the owners hired a different valuer for the IPO valuation even though they had just had the property appraised for RMB 20 billion on October 31, 2010, an increase of RMB 8.8 billion from the end of 2009. The new valuation, done three months later by a member of both the Royal Institution of Chartered Surveyors and the Hong Kong Institute of Surveyors, was 57% higher, although mall rents had only gone up 6.7% in the previous year and office rents had gone up just 1.9%. It all looks suspicious when the distribution of a huge revaluation surplus is dependent on such a high valuation.

The last DTZ valuation from October 31, 2010 explained the big increase in value to RMB 20 billion from RMB 11.2 billion as the result of declining capitalization (yield) rates, with the yield rate on The Malls moving down from 10.5% to 8% and the yield rate on The Offices moving down from 9% to 7%. The new valuation by American Appraisal China, on the other hand, applies even lower but contradictory yield rates, with the report stating that the respective yield rates on The Malls and The Offices as 6% and 5.5%, but the Valuation Certificate stating yield rates as 5% for The Malls and 4.5% for The Offices, indicating some change of heart during the valuation assignment. The valuation report does not present evidence for a 4.5% yield rate for offices.

As a point of reference, the Japan Real Estate Institute's Global Real Estate Markets Survey of 105 firms, published in May 2011, indicated a prevailing yield rate of 7% for Beijing offices, 7.1% for the CBD, up from 6.5% six months previously and 6% one year before.

In addition, the decrease in yield rates alleged by the new valuer seems to be at odds with the Chinese government increasing interest rates 5 times in the last eight months. There is usually some correlation between yield rates and interest rates.

As for the Direct Comparison portion of the valuation report, I was surprised to find so much of the "comparable" data consisted of asking prices rather than closed prices.

Distribution of the Revaluation Surplus

This "pre-listing distribution" of "the revaluation surplus" is part of the debt that was retired by the proceeds of the IPO. This is what allowed the owners to pocket over $1 billion in phantom capital gains immediately prior to public trading.

If Superman is reducing his stake in Hui Xian, why should we be buying?

One advertised virtue of the offering was that it was the first yuan-denominated offering outside China, allowing Hong Kong and offshore investors to invest yuan deposits that would otherwise yield lower returns in bank interest or in “dim sum bonds”. The anticipated yield was 4.26%.

The offering was subscribed at RMB 5.24 per share, but plunged 10% on the first day of trading in April. The last trade on July 5th was RMB 4.69, about 10.5% below the original offering price.

As of March 31, 2011, all seemed to be well at Oriental Plaza. Occupancy was reported as follows:

Retail mall 100%
Offices 99.7%
Apartments 95.4%
Grand Hyatt 72.9% (a good hotel occupancy rate)

The IPO prospectus only had financials until October 31, 2010. For the first 10 months of 2010 compared to the first 10 months of 2009, revenues were up for the malls and the hotel but office revenues decreased from RMB 563 million to RMB 542 million and apartment revenues declined from RMB 82 million to RMB 74 million. Overall revenues were up, nevertheless.

Headwinds?

Perhaps someone at Hui Xian Holdings saw strong headwinds coming their way. For instance, Years 2011 and 2012 will have numerous tenancy expirations, including more than 99% of the office tenants, 67.4% of the retail tenants, and more than 99% of the apartment tenants.

Also, despite double digit growth in retail sales, the amount of retail space inventory has been increasing even faster in Beijing, and the local retail vacancy rate was last measured at 24%, although it is a much lower 7.52% in the Dongcheng district that contains Oriental Plaza. In the last 3 quarters of 2010, added new supply was about three times absorption (also known as “take-up”). So far, this has not affected the Malls at Oriental Plaza (completed in year 2000), which enjoy an unparalleled location in a prime tourist and office area.

Still, the forecast is for 1,249,000 square meters (13.445 million square feet) of new high-end retail space to be completed in Beijing during the next two years, including the following new retail properties in the Dongcheng district:

Project
Wangfujing International Shopping Mall 40,000 sq mtrs 430,570 sf
Beijing Gong Project 46,000 sq mtrs 495,000 sf
Macao Center 23,000 sq mtrs 247,578 sf
Wangfujing International Brand Center 70,000 sq mtrs 753,500 sf

Oversupply is always bound to hurt even the best retail properties.

As for office space in Central Beijing, the growth in demand has recently exceeded the growth in supply, with the vacancy rate declining into single digits and average rents of $29.35 psf per year in U.S. dollars.

There are other Class A office projects in the works in Beijing, however:

Project
CITIC Securities Plaza 70,000 sq mtrs 750,000 sf
Xidan Yinzuo Centre 80,000 sq mtrs 860,000 sf
Meisheng International Plaza 43,000 sq mtrs 462,000 sf
Parkview Green 80,000 sq mtrs 860,000 sf
Guosheng Center 140,000 sq mtrs 1,500,000 sf
Fortune Plaza Phase III 150,000 sq mtrs 1,615,000 sf
Aether Square 50,000 sq mtrs 538,000 sf

As for the Dongcheng District, the nearby new supply will not be directly competitive. The difference between the Dongcheng district and the central business district seems much like the difference between the Chicago CBD and its Magnificent Mile, considering that Dongcheng is situated next to the premier Wangfujing retail district in Beijing. My hotel in Dongcheng was near a Bentley dealer, for instance.

There is nothing to suggest that Oriental Plaza is suffering any problems at the moment, but the fact that “Superman” Li is reducing his stake and cashing out a “revaluation surplus” should not be an encouraging sign to investors. Considering that Oriental Plaza was valued at RMB 31,410,000,000 but market capitalization of the trust was never that high and has now declined to RMB 23,550,000,000, perhaps that imaginary RMB 7.3 billion revaluation surplus should be returned to investors.

Disclosure: I have no short or long position in this stock.

Perennial China Retail Trust IPO 鹏瑞利中国零售信托

2011-06-10T00:11:00.000-07:00

After visiting vacant new malls in China, I was naturally intrigued to know the rationale behind this Chinese mall IPO, which was originally scheduled to go public in March but was then delayed until June 9th and priced 30% lower. The rationale may become more apparent by the end of this blog.

The press release stated that “PCRT offers investors the unique opportunity to participate in urbanisation-driven retail growth opportunities in China via a private-equity fund structure, typically accessible to only large institutional investors…PCRT's initial portfolio comprises five assets located in Shenyang, Foshan and Chengdu. The assets are Shenyang Red Star Macalline Furniture Mall, Shenyang Longemont Shopping Mall, Shenyang Longemont Offices, Foshan Yicui Shijia Shopping Mall and Chengdu Qingyang Guanghua Shopping Mall, and have a total gross floor area of approximately 960,899 sq m [10,343,369 square feet] and a total valuation of approximately S$1.1 billion as of December 31, 2010. …” The common special attribute for each property is that it will be served by either rapid transit or high speed railway stations.

Only one of these projects has been completed -- the 3 million square foot Shenyang Red Star Macalline Furniture Mall, a nine-story furniture mall which opened last September and was reportedly 91.8% occupied by the end of the year. This mall exclusively sells home furnishings, building materials and furniture. The property manager is Red Star Macalline Furniture, China's most successful furniture retailer, with 66 stores throughout China, double the number of stores open in 2007.

China Daily reported in March that home improvement retailers in China are facing growing challenges. French retailer Saint-Gobain recently shut down all its Shanghai stores, stating that "the individual demand for interior settings is dwindling since more housing and apartments will be sold with interior decorations. Our business, which is based on individual demand, becomes increasingly difficult." Likewise, Home Depot has closed 5 of 12 stores in China, and British home improvement chain B&Q has closed 22 stores (including Shenyang) and reduced the size of 17 stores out of a total of 63 stores in China. Perhaps the foreign retailers don't know how to compete with Chinese retailers, but a recent statement from a VP at China Building Materials Circulation Association sounds ominous: "The need for building materials is falling because people, even those needing houses to get married, are watching the property market instead of buying houses and decorating them. They expect housing prices to fall significantly."

That's the problem with the home furnishings and building materials industry -- it is dependent upon a robust housing market, and if that market were to deflate, like it did in the U.S. and U.K., the home furnishings industry would deflate, too. This would suggest that furniture malls could experience increased vacancies during the next Chinese recession, just as many furniture retailers failed during the U.S. housing bust.

Meanwhile, Standard & Poor’s cut its outlook on Chinese real estate developers to “negative” from “stable” on June 15 because of government tightening of credit markets, which may lead to further rating downgrades in the next year. The Chinese government has increased the required reserves for bank lending on commercial real estate nine times in a row.

Realistically, though, could one really put over 800 competitors together and expect all to survive? Red Star isn't a conventional mall with tenant complementarity.

Another, more fundamental question to ask is whether China is really wealthy enough to support the large number of luxury shopping malls being built at one time, considering that the median household income there is only about 10% of U.S. median household income.

The remainder of the PCRT portfolio

The even-larger, adjacent, Shenyang Longemont Shopping Mall (3.5 million square feet) is scheduled to open in the third quarter and was said to be only 51.8% pre-leased to 185 tenants at the time of publication of the prospectus. The other projects will not be fully completed until the end of 2014. PCRT also claims to have S$3 billion (Singapore dollars, worth about 81 U.S. cents) worth of purchase options for commercial sites next to the coming High Speed Rail in China.

CEO Pua Seck Guan stated, "Among all the markets that I'm familiar with, I think that China offers the most exciting and best potential. The reason being, one, today you can get real estate at a very attractive price, and you can see the yield that you can get. Therefore you can see the arbitrage of the physical market value into a capital market. “

If that statement doesn't make sense to you, you can understand why I'm skeptical, too. I would have more confidence if Mr. Pua just said, "I want to build profitable malls" rather than "I want to make a 'pure play' on Chinese retail." The latter statement resembles the talk of a gambler rather than a businessman. Bernie Madoff and Ivan Boesky both also liked to use the word "arbitrage."

One must also never forget that these are all leasehold properties, with ground leases expiring in 38 to 40 years, which reduces the prospects for long-term capital appreciation. This is China, remember; everything is leasehold. Yet Pua's justification for the initially below-average yield was the superior prospects for capital appreciation in this property portfolio.

The Feasibility Study

It is interesting to see how the 594-page PCRT prospectus has placed a positive spin on a February 2011 feasibility study from Urbis of Australia that presents more cause for concern, particularly about Shenyang, where three of the five properties are being developed. The IPO prospectus represents the Shenyang retail occupancy rate as 95 to 100%, but the feasibility study indicated an overall 83% occupancy rate for Shenyang shopping centers, most of which were built in the last decade. The report also mentions other competitive malls under construction in the same East Zhongjie neighborhood of the Dadong section of the city, such as:

Tianrun Plaza East Zhongjie 130,000 sq mtr Shopping Mall
Fengrui East Zhongjie 325,000 sq mtr Department Store
East Zhongjie Plaza 580,950 sq mtr Shopping Mall
Dunan Qiansheng Mall East Zhongjie 230,000 sq mtr Shopping Mall

This represents 1,265,950 square meters, or 13.6 million square feet of oncoming competitive retail space in the same part of town on top of an existing inventory of 340,000 square meters, a quadrupling of retail space in the East Zhongjie area alone, but does not mention the scope of the 4.37 million square meter (47 million square feet) Longemont Asia Pacific Centre mixed use project the PCRT properties are a part of, which also includes in its first phase the following competition:

1. The 32,000 square meter Asia-Pacific Department Store
2. The 100,000 square meter Asia-Pacific Digital Mall
3. The 25,000 square meter Regent Department Store
4. A 400,000 square meter major department store
5. A 30,000 square meter Vogue Department Store

That's 587,000 square meters (6.3 million square feet) of adjacent competitors within the Longemont Asia Pacific Centre development.

What will vacancy rates be like one year from now? Will these new malls and department stores draw away tenants from the PCRT malls?

From Savills Research and Consultancy -- The red square represents the three Shenyang projects situated in East Zhongjie.

As for local spending power, the study indicates annual retail expenditures per capita of just RMB 8926, or about $1377 USD. Is this supportive of “mid to high end retail”? There seems to be a misconception among foreign investors that most Chinese people are now affluent.

The feasibility study’s conclusion of feasibility would offend the reason of any numerate person:

"Given the expectation for continued strong economic growth and growth in personal incomes, the impact of any ‘oversupply’ is likely to be reasonably short, with the market adjusting over the following couple of years."

This would imply that a quadrupling of retail space in the neighborhood could be matched by a quadrupling of local retail spending within two years. Anyone who has completed Lesson 1 of Economics 101 would be skeptical of such a conclusion. The report lacks quantitative analysis of supply and demand, such as a forecast of local retail space absorption or vacancies.

Despite the deluge of new space being developed, the Sponsor has assumed a 1% vacancy rate for the retail malls, continued 6% annual growth in rental income and 15% annual growth in retail spending.

The Red Star Mall has opened to reported occupancy of 91.8%, but will a one-concept mall have staying power, particularly if the housing market was to recede?

As far as the talk of “yields you can see” is concerned, only the Shenyang Red Star Mall is producing income at the moment, and the malls in this trust will not be fully operational until the end of 2014. The IPO sponsor has forecasted a 5.3% yield in 2011, a tall achievement from mostly unfinished malls. The first distribution will be from the Earn-out Deed, which was taken out of the offering proceeds and is thus a return of capital and not a return on capital.

The reason for an IPO outside China

The use of an IPO on a foreign exchange to get financing is a result of the Chinese government’s crackdown on commercial real estate lending by banks. Escalating reserve requirements have hamstrung the ability of Chinese banks to lend on commercial real estate development, so developers must look outside China for financing. Somehow, sponsoring a risky real estate project on a foreign stock exchange gets taken seriously as an investment grade project.

The valuation [appraisal] report

The PCRT portfolio was valued at the equivalent of S$1,132,906,000 as of December 31, 2010, and the initial IPO was scheduled to be 1.1 billion shares priced at S$1 per share. The IPO was then postponed until June and finally fully subscribed, selling 1,121,695,000 shares at 70 cents per share (SGD), or S$785,187,000, 30% below the previously appraised value of the properties.

The S$1.1 billion valuation seems questionable, though, if it is meant to represent the current value of the intended PCRT portfolio as of December 31, 2010, as the valuation report does not disclose until the Appendix that the estimates of value were based on hypothetical conditions, mainly that all 5 properties were built, fully leased, and fully owned by PCRT. The only open and leased property, the Shenyang Red Star Mall, was valued at about $186 SGD psf, but the other incomplete or unbuilt properties were given similar appraised values. The incomplete Shenyang Longemont Mall was valued at S$187 psf and the incomplete Longemont Offices were valued at S$193 psf. The unbuilt Foshan mall was valued at S$205 psf and the unbuilt Chengdu mall was valued at S$156 psf. These estimates of values could not be reflective of the condition of these properties on December 31, 2010, making the valuation report misleading and inaccurate, as two of the five assets are currently just purchase options for projects that have not yet been developed.

Such a valuation report, if published in the U.S., would be considered a "misleading report" in violation of U.S. appraisal and banking laws. In the U.S., prominent disclosures of such hypothetical conditions affecting appraised value are legally required to be in the body of the valuation report; it surprises me that squeaky-clean Singapore does not require disclosure of misleading “hypothetical conditions” for a public IPO.

Moreover, the valuation report in the prospectus did not even consider that PCRT was acquiring only a 50% interest in the Shenyang properties, so they mistakenly valued the portfolio for 10.152 billion RMB (about S$1,932,000,000) and PCRT was the one to make the adjustment for 50% ownership in the prospectus. The valuation firm was CB Richard Ellis.

Investors need to realize that whenever an IPO sponsor orders an independent valuation or feasibility study, that study cannot be considered truly “independent”. The only independent study investors can rely on is one they order for themselves. Sorry to say this, being a valuer [appraiser] myself, but too many valuers are paid whores.

How the sponsor benefits from the IPO

So given the risk and uncertainty, what’s in this IPO for the Sponsor? The sponsor is appointed as the “Trustee-Manager” and is compensated as follows:

1. An annual base fee of .35% of appraised value up to S$10 billion. Based on the inflated CBRE valuation of $1.1 billion, the Sponsor would be owed S$3,850,000 this year. Will the Sponsor keep hiring this same valuation firm?
2. A performance fee of 4.5% of net property income (on top of the management fee paid to the actual property manager, Red Star Macalline).
3. An annual trustee fee of .03% of appraised value, or S$330,000 this year.
4. An acquisition fee of 1.35% of the acquisition price of the properties in Shenyang and Foshan ($820,000,000 SGD), which would provide the sponsor another S$11,000,000 in compensation.
5. Development and property manager’s fees of 2% of gross revenues + 2% of net property income + .5% of net property income.
6. Leasing commissions of two months’ gross rent for newly completed or renovated buildings.
7. A divestment fee of .5% of the sale price of any real estate sold or divested.

The prospectus also indicates that PCRT's sponsor will earn S$141,800,000 in acquisition and development fees for the Chengdu Mall and S$121 million for the Foshan Mall. So development seems to be a profitable option for PCRT's Sponsor, no matter what.

The bottom line is the Sponsor is superbly compensated no matter what happens to the properties in this portfolio, much as a syndicator is (See my blog about international real estate syndications). The piece de resistance in this scheme is that the Trustee-Manager can only be removed by a 75% majority vote of the unit-holders, so desperate is the Trustee-Manager to hold on to this gravy train. This is even disclosed as a risk in the prospectus: “There may be difficulty in removing the Trustee-Manager.”

My overall opinion of PCRT is that it is bad for investors, but good for the sponsor. While advertised as a "pure play" on the Chinese retai sector, it is also a pure play on Chinese real estate development at an inauspicious time. For instance, Standard & Poors has just reduced its outlook to "negative" for Chinese real estate developers due to Government efforts to restrict bank lending to them.

My skepticism does not count for much. What does the market think?

The IPO was originally priced at S$1 per share, then 70 cents SGD per share. Trading in PCRT on the SGX started on June 9th at 65.5 cents per share, and in the two weeks since the unit price has declined to 58.5 cents per share for a market capitalization of S$656,191,525, which is 42% below "valuation".

Disclosure: I have no short or long position in this stock. I will reconsider when I visit the properties in September.

Fraud in International Real Estate Transactons

2011-06-08T16:34:00.000-07:00

Ecological preserve represented as potential residential subdivision

Working for Jones Lang Wootton back in the 1980s, I sometimes received phone calls from our foreign offices, usually in Asia, inquiring about some Houston property that was being marketed in their country. These were typically the hardest-to-sell properties, and seemed to fit a pattern operating in both directions, which is this:

1. The hardest-to-sell properties must be marketed the furthest distances to find buyers or lenders.
2. The best real estate opportunities tend to get picked off by local investors.
3. The riskiest or least desirable properties also need to search the furthest distance for financing.
4. The real estate business attracts charlatans, but it is difficult to spot charlatans from the other side of the world, which is why the charlatans seek out foreign investors and financiers.

Nowadays, the overseas properties I am sent by private lenders to appraise often turn out to be mangrove swamps or sugar cane plantations with dreams of being turned into 5-star resort developments — in other words, high risk deals that have already been passed over by other lenders.

Here are some of the misrepresentations I’ve seen in the last three years:

1. A Mexican property in which the owner substituted an uso de suelo (public document identifying the property and its permitted land use) for a superior property in place of the actual property. The actual property, which was intended for residential development, was an ecological preserve with protected species of mangroves and crocodiles.

2. A substantial portion of a property in Fiji was on a native land lease expiring in one year and the remainder was on another “crown” land lease. The owner also falsely claimed to have government permission to remove protected mangroves along the shoreline.

3. A phony purchase contract for an Australian nursing home.

4. A Canadian developer represented web site inquiries as pre-sales.

5. A Costa Rican development claimed to have full entitlements, but only the first of its three phases was approved.

6. Most transactions were supported by misleading appraisal reports, ordered by the borrower and often prepared by designated appraisers from some of the world’s best known appraisal companies.

7. Proposed developments were often supported by biased feasibility studies from some of the world’s best known consulting firms. What makes me consider the feasibility studies biased is when there are no pre-sales but the feasibility of the project is considered certain.

Seller-ordered appraisal and feasibility reports

Some words of advice for investors or lenders provided with unsolicited appraisal or valuation reports: If you did not order it or select the appraiser/valuer, do not trust the report, no matter how credentialed the appraiser or how famous the firm. One internationally famous real estate appraisal and brokerage firm, for instance, is facing over $24 billion in appraisal fraud-related lawsuits. Too many appraisers are whores, and circumstances in the last decade have elevated some of these appraisers and appraisal firms into the ranks of the world’s most widely used appraisers.

As for appraisal designations, I have never seen meaningful ethics enforcement by the conferring organizations. These appraisers may have had their U.S. appraisal licenses revoked by government agencies for their misconduct or may have been found guilty in malpractice lawsuits, but they always get to keep their memberships in the private organizations that have conferred their designations. One international organization even elected one such appraiser as their president while he was undergoing disciplinary proceedings in his home state. When I asked them how they could elect such a person, they told me that he had “voluntarily surrendered” his appraisal license, which somehow allowed the pretense of innocence.

The bottom line is: Order your own studies from your own trusted expert.

Pre-construction buying opportunities

Pre-construction discounts are often proportional to the riskiness of the development. Investors are often provided guarantees of refunds if the project does not commence and then find out that the guarantees are not honored or enforceable. The Florida courts are crowded with aggrieved investors trying to get their money back on Florida condos, and an investor should also seriously consider his chances of success in a foreign judicial system.

Be particularly wary of making substantial cash down payments on undeveloped lots in Latin America that are being sold with promises of roads and utilities to be installed in the future. It might be instructive for prospective investors in raw land to read the legal complaints filed against Paradise International Properties of Costa Rica, for instance, which pretty much explain everything that could go wrong in investing in raw land in Latin America. At the least, hire an independent attorney to find out if the land has even been legally subdivided.

Costa Rica and Mexico have recently been hotbeds of real estate fraud, and the fraudsters are often American, too. Consider that neither country requires real estate brokers to be licensed and that their fraud laws are less strict than U.S. fraud laws, as they are based on the Napoleonic system of justice of “No harm, no foul”, meaning that unless you physically injure somebody, you can pretty much conduct business as you want. Lawsuits in those countries can be futile.

U.S. properties marketed overseas

Any property having trouble being sold in the U.S. can sometimes find itself being marketed overseas.

Lately I have been getting offers through LinkedIn to market properties to the Chinese.

It is no accident, either, that on a Chinese web site marketing US residential investment opportunities, one finds ads from the most overbuilt vacation condo communities in the U.S., such as the Disney World market, which includes Orlando, Championsgate, Kissimmee and Davenport. The geographical area described as “just 3 exits from Disney World” encompasses thousands of vacant, bank-owned condos. Such an investment might make sense to a foreign investor genuinely wanting to own an inexpensive condo near Disney World, but some ads talk about “guaranteed rental income” and “guaranteed appreciation” as if such condos make good income property investments and the oversupply would end soon. I was sent by one client to appraise a package of 15 brand new rental condos in Kissimmee, for instance, and found only one occupied, which is not unusual for this extremely oversupplied market.

Also be suspicious of rental properties with guaranteed rental income for the first year or two, particularly in Arizona and Nevada. Such guarantees would not be made unless the rental income after the guarantee period was in doubt. The guaranteed income is often added to the sales price, any way, and these properties are often sold with spurious “management services”. Perform an Internet search of the management companies and you will often find a litany of investor complaints. If no information can be found, Google the principal of the company, and you may find a fraudster who has been moving around from state to state or country to country.

An overseas investor might also be surprised to find that U.S. securities laws do not apply to U.S. real estate investment securities marketed overseas. For instance, Australian hedge fund Basis Yield Alpha recently lost its lawsuit against Goldman Sachs for a $78 million loss in a Goldman-sponsored CDO (collateralized debt obligation) known as Timberwolf 2007-1. Goldman profited by betting against this CDO, as they have been known to do, and faces other investor lawsuits, but Judge Barbara Jones dismissed the Australian lawsuit solely because U.S. securities law only governs securities sold within the United States. This jurisdictional exception was upheld by the U.S. Supreme Court last year. Korean life insurer Heunkuk Life Insurance is similarly affected.

Why international real estate attracts fraud

Fraud is most effectively practiced where there is ignorance, and foreign real estate investors are often at a disadvantage in obtaining all information they need on an investment being made in another country. Sellers of real estate know how to exploit this information disadvantage. That is why one needs to proceed cautiously in investing in (or lending on) foreign real estate.

Private Housing in Singapore: Choice Between Luxury or Squalor?

2011-06-07T16:47:00.000-07:00

Singapore is bursting at the seams from population growth, but much of the growth has been in the population of foreigners (permanent residents and nonresidents), particularly the category known as non-residents, who are temporary workers. The foreigner population increased from 1.1 million in the 2004 census to 1.8 million in the 2009 census (out of a total population of about 5 million). Of this increase of almost 700,000 people, 500,000 were non-residents, who are legally excluded from public housing. Roughly 85% of Singaporeans live in public housing, a necessity in a city-state with a shortage of land and housing.

Whereas most developed countries have a full continuum of housing options for almost every socioeconomic level, Singapore seems to have distinct and discontinuous categories of housing, which are:

1. Upscale housing for foreigners and wealthy Singaporeans. About 16% of owners in this category are foreigners, and half of foreign buyers are from China or Indonesia.

2. Public housing for middle class and lower class citizens, which is generally of a higher quality than public housing in other developed countries.
3. Substandard housing for low-wage nonresident workers.

The vast majority of housing consists of “non-landed” homes, or apartments and condominiums, as land is scarce.

The income ceiling for public housing eligibility is a maximum of 12,000 Singapore dollars (SGD) per month ($9768 USD), depending upon family size. Thus it is conceivable for an extended family earning $100,000 per year to live in public housing, much of which is nicer in quality than that of other developed countries. Median household income was 60,000 SGD last year, or $48,840 USD, very similar to the United States.

The median private home price is estimated to be about 850,000 SGD, or $692,000 USD, although actual sales prices are kept confidential and Singapore’s Urban Redevelopment Authority only publishes price per square foot. Even “non-prime” private homes are selling for an average 1043 SGD ($850 USD per square foot), while luxury homes have recently sold for up to 3277 SGD, or $2667 USD per square foot. The reason why such high prices are possible is because of Singapore's amazingly low mortgage interest rates, which can be as low as 1% per annum. This leaves the private housing market vulnerable in the case of an increase in interest rates, although there are a fair number of cash buyers of private homes, particularly Chinese buyers.

Despite new government policies intended to slow the rise in private property prices, such imposing as a stamp duty of 16% on homes owned for less than one year and lowering the allowable loan-to-value ratio to 60% for borrowers who already have other mortgage debt, the median home price increased by 17.6% last year and increased another 2.2% in the first quarter of 2011. The number of wealthy Chinese buyers is increasing.

Low income housing

Unlike Los Angeles, where immigrant workers arrive individually and find affordable housing options on their own, Singapore employers and staffing agencies recruit migrant workers in large numbers and then create makeshift dormitories for these workers. Crowding can be intense.

Income disparities are high in Singapore, which leads the world in percentage of millionaire households (15.5%) but lacks a minimum wage, thus allowing significant importation of cheap labor. For instance, I met a group of 3 Filipino workers who told me that they were living 4 to a bedroom and earning a salary of 500 Singapore dollars per month (about $400 USD) working at local Burger Kings. Burger King, as well as many other Singapore employers, subcontracts recruitment to staffing agencies, who in turn find the workers in the Philippines, China, India, Bangladesh, Sri Lanka or Thailand and transport them to Singapore and provide free housing and utilities, as any worker earning only $400 per month would not be able to find affordable housing on his or her own. The shortage of labor in Singapore (with an unemployment rate of about 2%) and the lack of desire of Singaporeans to perform menial jobs has made it necessary for employers to import labor, and the shortage of housing makes it necessary to provide free housing for the imported labor.

Although Singapore has standards of habitability for residential occupancy, the shortage of affordable housing has created a class of illegal and substandard housing, including the following examples:

1. Industrial space illegally converted to residential space. The photo below is from a raid on an illegal dormitory for temporary construction workers. Notice the corrugated metal walls and ceiling. There seems to be no evidence of HVAC and limited ventilation, something needed in Singapore’s equatorial climate.

Photo of a dormitory on Tagore Industrial Avenue. Credit: Asia One News

2. An underutilized "gay sauna" in Chinatown rented a block of private rooms to nonresident workers. This presumably led to some embarrassing confusion between incompatible guests.

3. Truck containers, 18 men per container.

Photo credit: The Online Citizen

4. Basements.

Photo credit: The Online Citizen

Issues about housing affordability and the crowding caused by immigrants were hotly debated in the campaign leading up to the May 7th parliamentary elections. The ruling party, the PAP, nevertheless held on to its parliamentary majority, losing only one out of 82 contested seats. Nevertheless, it only won 60% of the vote, the lowest percentage since the founding of the Singaporean state in 1965. This is considered to reflect growing discontment among citizens about the growing number of foreigners, who cause congeston and take jobs, the growing wealth disparity between the haves and have-nots, and the inability of young citizens to afford housing nowadays.

Costa Rican and Mexican appraisals

2011-06-03T14:42:00.000-07:00

Condo development site in Cozumel, Mexico

I am more often asked to review local appraisals from Mexico and Costa Rica than I am asked to appraise in those countries, as most clients are cost-conscious. Appraisal reports look very different in Mexico and Costa Rica than in the U.S. and Canada. These are the major differences I see between Central American and North American appraisals and appraisers:

1. An appraiser in Mexico or Costa Rica is likely to be an engineer or an architect. In this respect, Central American appraisers generally have more relevant college degrees as compared with North America, where any college degree, no matter how irrelevant, meets the criteria for designations and certifications. They tend to be very precise in their measurements, too.

2. Most Central American appraisal reports are delivered in Spanish, and few appraisers speak English. On the other hand, almost any successful real estate broker in either country is likely to speak English.

3. A Central American appraisal report presents no market data or comparable sales. This reduces the incentive to perform market research, and market research is particularly difficult in these countries because of the inaccuracy of public records, as the sales prices that are recorded are often a fiction serving the agenda of buyers or sellers, usually to avoid taxes.

4. Central American appraisers, probably because of their architecture or engineering backgrounds, seem to rely too much on the Cost Approach, which is land value + replacement cost – depreciation. Nowadays, many properties are selling at below cost as a result of economic depreciation (oversupply), but an appraiser not measuring market trends might only measure physical depreciation and nothing else, so the Cost Approaches end up being high.

5. Ethical standards for Central American appraisers appear to be low. Most appraisals I have seen have had inflated value estimates serving the clients who hired them; I often find this out when I find the property advertised for sale on the Internet for a price well below appraised value. One firm claims to deliver MAI appraisals, but there are no MAI appraisers in Costa Rica. Some brokers offer “free appraisals”. Right.

6. When U.S. appraisers perform valuations in these countries, they often do not include comparable sales, either, and instead construct a discounted cash flow model based on assumptions not fully validated through market research. The results of a DCF analysis can vary significantly based on the assumptions used in the DCF model.

Is there an appraiser who includes comparable sales and listings in his Mexican and Costa Rican appraisal reports? Yes. I do. After all, what good is an appraisal that does not rely on comps?

South African game farm appraisal

2011-05-29T12:31:00.000-07:00

Interior of hunting lodge

I have been asked about the photo at the top of my blog page. This photo was taken from a lodge at a South African game farm I appraised in 2008. It is located in the Waterberg, an upland area about an hour north of Pretoria. With an elevation of about 1000 meters, it is in an area with a mild, malaria-free climate.

I have recently found the same game farm for sale for 3 million UK pounds, or close to $5 million USD, lower than my appraised value and far lower than the South African appraiser’s estimate of value of 70 million rand, or about $10 million USD.

A game farm is basically a ranch that contains indigenous African animals and earns its revenues by hosting wealthy hunters or other tourists, such as photographers. Hunters pay for the animals they shoot. The hunters also have the option of eating what they kill, paying farm staff to prepare the killed animals for consumption. If the hunters do not want the meat, it may be sold to a local restaurant. At the game farm I appraised, the most expensive item on the menu was the white rhinoceros, which cost $25,000 to kill.

The game farming industry claims to be a greener alternative to conventional ranching, as indigenous animals live in better harmony with nature, consuming the full range of vegetation offered, while domesticated animals tend to denude the grasslands and need to be inoculated for disease. For example, there was a recent outbreak of “Foot and mouth disease” in the Kwazulu-Natal province this year.

So what is happening in the South African game farm market? Three years ago, billionaires such as Richard Branson and Howard Buffett (son of Warren) were buying their own game farms, and game farms were appreciating rapidly in value as the result of an increase in tourism by wealthy European hunters. The number of game farms was also proliferating. Nowadays, there are hundreds listed for sale.

Political rumblings

There is a vocal politician in South Africa’s ruling party, the ANC (African National Congress) who is causing some concern among game farm owners. Julius Malema, President of ANC’s Youth League, gave a speech at an ANC election rally two weeks ago which included the following remarks:

“They (whites) have turned our land into game farms…We must take the land without paying. They took our land without paying. Once we agree they stole our land, we can agree they are criminals and must be treated as such”

President Zuma, also a member of ANC, rebuked Malema and stated that land expropriation was not the policy of the ANC. Nevertheless, the gap in wealth between blacks and whites is still a divisive issue in this black-governed nation which has been ruled by the ANC since 1994. Mr. Malema is said to have a special appeal to young, poor, black voters and is an advocate of having the government nationalize the country’s assets, particularly its mines.

Market analysis

While not finding any current data on price trends in the game farm industry, the following information makes me wonder if there is a price correction about to occur in the South African game farm industry:

1. Seeing a game farm for sale at less than two appraised values.
2. The sheer number of listings of game farms for sale, including over 120 listed for sale with Africa Game Farms and 108 listed for sale at Africa Game Farm Estates.
3. Political rhetoric advocating land expropriation.

Valuation analysis

From an appraiser’s point of view, valuation can be tricky, as sales of game farms typically include a considerable amount of personal property – the animals themselves. Considering that a game farm without animals would no longer capture revenues from wealthy tourists, the real estate component of value is considerably less than going concern value.

Going concern value = real estate value + personal property value + business enterprise value.

The South African valuer took a different approach which essentially added the depreciated replacement cost of all of the improvements to the market value of the game-stocked land, based on sales of comparable game farms, thus including personal property value within the estimate of land value. This is a dangerous way to appraise collateral for lending purposes, which is one reason why this client sends me to appraise in other countries – valuation methods and standards differ.

My client was an adventurous private lender. I advised them that if they wanted to lend based on going concern value, the animals would have to be insured, as animals can be lost to poaching, theft, disease or natural disaster. The seller of the farm told me that he had already looked into insuring the animals, and the insurance costs would be too high for profitable operation of the game farm. In the end there was no loan and no sale.

Canadians to the rescue in the U.S. Southwest

2011-05-27T16:07:00.000-07:00

Canadian-owned Desert Dunes Golf Course in Desert Hot Springs, CA

The previous blog mentioned the activities of Canadian real estate syndicators in the U.S. southwest and Latin America. This is only part of a significant Canadian buying spree that I see happening throughout the U.S. “Desert Southwest”. Most of the Canadian buyers are actually couples or families.

The oil and potash boom in western Canada has provided new wealth to many Canadians, and now that the Canadian dollar is worth more than the U.S. dollar, many Canadians are taking advantage of the oversupply of homes in the U.S. Desert Southwest to buy themselves winter vacation homes, as winters in Alberta and Saskatchewan are legendary for their dreariness.

In my Saskatchewan blog from last October, for instance, I did not mention that on my flight from Las Vegas to Canada I sat next to a Canadian woman who had just purchased a Las Vegas home for herself and her husband.

I’ve also met Canadian buyers in Phoenix and Tucson and most recently I have encountered a wave of Canadians buying in California’s Coachella Valley, better known as “Palm Springs”.

In February I appraised the Desert Dunes Golf Course, a beautiful, Robert Trent Jones-designed golf course bought out of foreclosure by Canadian investors. They have been bringing in many Canadian tourists, and many tourists like the quality and prices of the residential real estate that they see there. For those who are interested, the lender was Kennedy Funding out of New Jersey.

I am currently appraising a recently completed condo complex next to another golf course in Cathedral City, immediately east of Palm Springs. Only 6 out of 40 units have sold so far, but the buyers have been Canadian.

Lantana at Cimarron Condominiums in Cathedral City

Areas of the Desert Southwest having significant oversupply of unsold homes and condos include the Las Vegas, Phoenix, Tucson and Palm Springs/California Inland Empire areas.

As for the Coachella Valley/Palm Springs area, the amount of residential oversupply appears to have stayed constant for a while, with Dataquick reporting a 7% decline in median residential prices in the last year as of April 2011.

The Cathedral City condo market in particular has about a 13-month supply of condos for sale, about the same as 18 months ago. Realtors generally say that a balanced market should have no more than six months of unsold inventory, so further condo price declines are likely. For an investor or flipper, this is not good news, but for Canadians seeking vacation condos, this has brought the median condo sales price in Cathedral City down to $115,500 (or 112,769 Canadian dollars), so this may be a good time to pick up a bargain to enjoy over the long term, taking advantage of the favorable Canadian/US dollar exchange rate. Prices are still declining, though, so no one should feel rushed to buy.

Warning about international real estate syndications

2011-05-21T03:36:00.000-07:00

Unsold Arizona condos are a favorite among Canadian syndicators.

What is a real estate syndication?

A real estate syndicator is one who organizes groups of investors (or “syndicates”) to acquire real estate investments. The syndicators are paid fees from investors for spotting and sharing profitable real estate investment opportunities with potential investors. The process is called syndication.

Real estate syndication achieved a bad reputation in U.S. in the 1970s and 1980s as an investment vehicle that enriched syndicators at the expense of investors.

Lately, I have seen such syndications go international. They may start in the Canada, for example, and recruit Canadian or UK investors to invest in US real estate or Latin American real estate without involving a single US investor. They typically overpay for properties because they are compensated in proportion to acquisition prices. I am not implying that Canadians are any more dishonest than Americans, but I have noticed that sentencing is much lighter in Canada for convicted fraudsters.

Canadian Ed Okun was not as lucky, having been sentenced to 100 years in US Federal prison. Here is his story:

Ever since he was a young man in Canada, Ed Okun dreamed of living a lifestyle of the rich and famous. His first wife described him as a con man who stole $150,000 from his father-in-law and raided his own family’s trust fund to buy a 53-foot yacht, Rolls-Royce, Aston Martin and Mercedes before fleeing to the United States to escape a civil judgment. Just prior to his arrest in the U.S. for embezzlement, he drew unfavorable attention to himself with a small dinner party in the Bahamas that cost more than $56,000, a fact eagerly disclosed to law enforcement by his second wife after he dumped her to marry a Brazilian call girl.

Ed Okun is perhaps an extreme example of the type of people the real estate syndication business attracts, but it is not a business that attracts saints. Otherwise, Mother Theresa herself would have been organizing real estate syndications.

Okun’s syndication scam

As a syndicator, Ed Okun claimed expertise in “identifying, acquiring and turning around distressed commercial real estate”. Okun, doing business as Investment Properties of America (IPofA), managed several such syndicates. Being a Certified Fraud Examiner, I was contacted by the lead investor of one such syndicate, composed of 20 senior citizens who lost all of their $13 million investment in Okun’s acquisition of the Park 100 Industrial Building in Indianapolis, the investment he arranged for them.

The Park 100 Industrial Building is an aging behemoth, a 459,000 square foot warehouse built in 1959, about the size of eight football fields. Unbeknownst to the syndicate, Okun already owned this building, for which he paid $3,300,000. As the manager of the syndicate, he then used his claimed investment expertise to have the investors pay him $12,650,000 for the building, earning him a 283% profit.

To justify such a high purchase price, he had to show that he was adding value, which he did by securing a tenant to pay almost $1 million per year in rent in addition to all operating expenses. The investors later found out that the tenant was a shill for Mr. Okun. The lease document between Okun and the tenant promised a $1 million incentive to be paid to the tenant “upon successful syndication of the property”. Thus, the tenant was chosen not to pay money but to consummate the syndication deal. The tenant occupied the property for about a year, but did not pay rent.

Also enabling the scam was a U.S. real estate appraisal firm which appraised the warehouse for $12,650,000 based on comparisons to 21st century warehouses. This same firm faces a $24 billion class action lawsuit in connection with the Credit Suisse syndicated loan fiasco involving the Yellowstone Club and other prominent resorts.

The warehouse was foreclosed on and has traded since then, but since Indiana is a non-disclosure state (good states in which to commit real estate fraud), the subsequent prices are not known. The local tax assessor has assessed its market value to be $4,125,400.

This quite common type of syndication scheme involves the syndicator organizing limited partners to acquire a major property, such as a mall. The syndicator usually shares few of the risks of the venture by taking huge upfront fees and minimizing his own equity in the investment. He may have already bought the property through another business entity and then sold it to the syndicate at a profit. Through another company which he owns he may receive substantial fees for management services. The syndicator uses his superior knowledge to take unfair advantage of the investors. The reported “acquisition price” is typically above market value.

In one recent Texas syndication the syndicators purchased a piece of land from themselves, on behalf of the investors, at a $20 million profit after a one year holding period, in a market with a growing inventory of large land parcels for sale at much lower prices. In addition to the $20 million profit, the syndicator earned fees of about $3,300,000 in selling commissions, $500,000 in wholesaling fees, $800,000 in placement fees, $600,000 in reimbursement of offering costs, $350,000 in underwriting fees, and $5,200,000 in reimbursement of offering and organization expense fees. This represents over a $30 million profit on a property that probably lost value since its original purchase as the demand for residential land waned.

Syndicators are thus able to acquire real estate or sell their own real estate with other people’s money and charge those people again and again for the right to take their money. One Internet course on real estate syndication (syndicationsuccess.com) teaches 17 different ways to extract fees from investors. Not to be outdone, New York University (NYU) offers a course this spring entitled Real Estate Investment Syndication: Acquiring and Managing Real Estate Using Other People’s Money, also promising to teach “maximizing opportunities to generate revenue.”

Meanwhile, many syndications are falling apart. 12,000 syndicate investors lost money in the DBSI bankruptcy two years ago, and an estimated 10,000 investors are affected by the current SCI bankruptcy. Both DBSI and SCI were American syndicators, located respectively in Idaho and Los Angeles.

There needs to be a cleanup of this culture of predation on small investors by the real estate syndication industry. Perhaps NYU can offer a course on that, too.

Hong Kong: Lofty Housing Prices, Low Capitalization Rates

2011-05-16T09:28:00.000-07:00

As a global financial center, Hong Kong ranks third and is rapidly catching up with New York and London, bringing in expatriate financial workers to fuel the Asian financial expansion, as Hong Kong is clearly the financial hub of the Asia-Pacific region. Its shortage of land also has created some of the world’s highest real estate prices.

In a recent government auction of land, for instance, three sites sold for a combined price of about $700 million. Sung Hung Kai properties, for instance paid $4.49 billion Hong Kong Dollars, or about $577 million USD, for the sloping 3.63-acre former Lingnan University site, equivalent to $1160 USD psf of land or about $3650 USD per buildable square foot, as the maximum allowed buildable area is only about 180,000 square feet. Completed homes, having views due to the slope of the site, are forecasted to sell for over $5000 USD psf.

China Overseas Lands bought a 30,237sf site in Kowloon for HK$578 million, or about $74 million USD, equivalent to $2458 psf of land. They expect to build only ten houses, which will sell at a price of over $3000 USD psf. The price per buildable square foot is $1850 USD.

While these land prices might not seem high by Manhattan standards, when one considers the low density zoning, the price per buildable square foot is much higher than Manhattan.

Real estate prices have been rapidly climbing in sympathy with near-record sales prices, and a high-floor condo near Lingnan University recently raised its asking price to over $3000 USD psf, with other sellers reported to be increasing their asking prices from 10 to 30%.

The highest recent home sale, at 20 Peak Road, was HK$750 million, or almost $100 million USD, equivalent to the highest residential sale ever achieved in the U.S. The average luxury home price psf was estimated by CBRE at HK$21,351, or about $2700 USD per square foot, 14.5% higher than one year ago, and the overall residential property index jumped 24% from one year ago.

Meanwhile, just as in Beijing and Singapore, the Hong Kong government is taking extra measurements to prevent a housing price bubble fueled by speculators, instituting a 5 to 15% tax duty on residential resales within two years of purchase, and lowering LTV (loan-to-value ratios) to 50% on all non-owner-occupied residential properties, in addition to the aforementioned auction of government land (although the balance between supply and demand could have been improved with some up-zoning).

The vacancy rate for the luxury rental market was last measured by CB Richard Ellis at 1.9% and falling as highly paid financial industry workers are imported into Hong Kong.

The highest reported recent house rental was about $25,000 USD per month for a house at The Peak, and the highest flat rentals have been at about $20,000 USD per month. CBRE estimated the average rent psf for luxury flats at HK$37.70 psf, or about $4.75 USD psf. Serviced apartments, a typical housing option for a visiting expatriate, are leasing in the range of HK$44 to $57 psf per month, 13% higher than one year ago..

As for multifamily investment, unleveraged yield rates are now below 3%, fed thus far by ultra-low mortgage interest rates by local banks, lower than 1% until recently, but some lenders are now starting to raise rates, with Hong Kong Financial Secretary John Tsang warning consumers and investors not to count on cheap credit forever. Meanwhile, mortgage interest rates are also increasing in mainland China.

Is the Hong Kong housing market a bubble waiting to burst? Housing prices were actually slightly higher in 1997, before the Asian financial crisis of 1998, which was started by a real estate bubble in Thailand. This time, the Hong Kong government is doing its best to implement measures to achieve a “soft landing”, legislating conservative LTV ratios and short-term gains taxes unheard of in the United States.

Macau: Surpassing Las Vegas as the World’s Top Gaming Destination

2011-05-14T03:10:00.000-07:00

Photo: Portuguese colonial architecture in foreground, high-rise living in mid-ground, Wynn and MGM casinos in the background. Below: Sands Casino behind Portuguese colonial architecture.

The growth in the Macau gaming industry has been staggering. In the first quarter of 2011, for instance, gaming revenues in Macau were 43% above the same period the year before, and year 2010 Macau gaming revenues of $23.5 billion are about 4 times the 2010 gaming revenues of the Las Vegas Strip. April revenues were 45% higher year-over-year and roughly 5 times Las Vegas Strip gaming revenues. Macau gaming revenues are predicted to increase another 35% this year, aaccording to Asian securities analysts at CLSA Asia Pacific. The last time the two gambling destinations were on a par in revenues was 2006.

It was not long ago that I was frequently sent to Las Vegas to appraise yet a new or proposed luxury condo tower featuring million-dollar-plus condos. “Who are the prospective buyers?” I asked. The standard response was that Las Vegas would become the preferred casino tourist destination of the world and that multi-millionaires from Asia and the Middle East would be clamoring for second homes in Las Vegas for their gambling holidays. The ultra-luxurious Turnberry Towers near the Strip had sold out their first two phases by 2006 while construction continued on the third and fourth phases, but by late 2006, it was apparent that many Turnberry buyers had actually just been speculators, and at the time of my inspection in November 2006, 25% of the units acquired in the first phases were listed for resale at significant discounts. Most had never even had their interiors finished, as the condos were sold in shell condition.

The American casino industry

The decline in U.S. casino gaming revenues in general (down 10% from 2008 to 2009), as reported in the American Gaming Association’s last State of the States report in July 2010, is partly explained by the economic recession. The top four gaming states by gaming employment in 2008, Nevada, New Jersey, Mississippi and Louisiana, saw respective decreases in gaming revenues of 10.4%, 13.3%, 9.4% and 5% from 2008 to 2009, and Las Vegas saw a 20% decrease in gaming revenues from 2007 to 2009. Despite the lessened demand for gaming in Las Vegas, one huge project hit the market, adding to the oversupply:

City Center, Las Vegas

This is a 16.8 million square foot mixed-use project in the heart of the Las Vegas Strip, developed at a cost of $11 billion and partly owned by Dubai World. Opening in December 2009, only 550 out of 2400 condos have been sold, the Aria Resort & Casino has lost $161 million in the first three quarters of 2010 and the Mandarin Oriental Hotel has lost $23.6 million in the first three quarters. In my visit to City Center in October 2010 I saw a spacious indoor retail mall with high-end retailers and few customers.

Macau

For Asian, Middle Eastern and European gamblers, Macau is more accessible than Las Vegas, and numerous flights are available to Hong Kong, with Macau being a one-hour ferry ride away. There are 100 million people within three hours driving time to Macau and 1 billion people within 3 hours flying time.

Unlike Las Vegas, with its inhospitable climate (100 degrees at night in the summer and cold and windy in the winter), Macau has a humid, subtropical climate that is relatively constant and pleasant for walking. Las Vegas can fool you into thinking that the next casino is only a one minute walk away, and then the walk turns into 15 minutes of seemingly walking straight into a blowdryer.

While the Las Vegas Strip funnels human masses along sidewalks partially blocked by hooker hawkers, tourists in Macau can walk in many different directions without waiting 5 minutes for a traffic light, and can explore the historic areas or retail areas without having to take a taxi that would only get stuck in a traffic jam if it was in Las Vegas. Macau also has an interesting mix of cultures; it is Las Vegas meets Lisbon meets Chinatown, as Macau was originally a Portuguese colony, and the street names and public signs are in the Portuguese language.

Colonial section of Macau

The 89-year-old Hong Kong billionaire Stanley Ho is the pioneer of the Macau gaming industry as the founder of SJM Holdings, but the major U.S. casino operators, Las Vegas Sands, MGM and Wynn, have also established large presences there, and both Sands and Wynn now receive the majority of their profits from Asia. As Mr. Ho declines into senility after having had brain surgery, there has been a highly public controversy over which of his four wives woul inherit his casino empire. The recent winner has been his fourth wife, Angela Leong, who was once a dancer and aerobics instructor and met Mr. Ho through a shared interest in ballroom dancing, but now controls a $1.2 billion empire of 20 Macau casinos; she now plans a $1.3 billion theme park resort with six hotels, an equestrian center, and an indoor beach, all while serving in Macau's legislature. Mr. Ho’s extended family controls about 30% of Macau gaming, with about 20 casinos.

SJM's flagship property, the Grand Lisboa

A recent Wall Street Journal article (4/18/11) on Macau gaming seemed to place the highest hopes on Hong Kong-listed SJM Holdings, a local favorite that has strong political connections and a price-to-earnings ratio of only 11 in this rapidly growing Macau gaming market.

Meanwhile, a joint venture between MGM Resorts International and Pansy Ho, daughter of Stanely Ho, is being prepared for an IPO on the Hong Kong Exchange as MGM China Holdings, as MGM tries to catch up with Wynn and Sands in capturing the rapid growth of Asian gaming. MGM Holdings plans to issue 760 million shares in the range of HK$12.36 to HK$15.34 per share (or about $1.60 to $2 USD per share.

I visited Macau during the weekend of the grand opening of the 2200-room Galaxy Macao resort, the most spectacular yet in Macau, which cost almost $2 billion to build on a manmade peninsula of reclaimed land called the Cotai Strip. Nearby is the Venetian, now the world’s largest hotel building, owned by Sands. The Cotai Strip is poised to become the high-end area of Macau, including some of the highest price condos in Macau.

Sands plans to open an even-larger casino in Macau next year.

The Chinese government has eased visa requirements for travel to Macau, opening the floodgates for China’s many nouveau riche gamblers. 75% of Macau’s gaming revenues come from high rollers from China. Ms. Leong, heir apparent to SJM, has specialized in lending gambling money to these high rollers, and Wynn also estimates 80% of its revenues and 60% of its earnings are due to high rollers. Moreover, planned bridges to Macau from Hong Kong and the mainland are estimated to expand the number of visitors to Macau by 50% in the next 5 years. High speed trains will transport gamblers from Guangzhou to Macau in less than hour, reducing travel time by about 70%.

Macau's government recently imposed a limit on gaming tables to 5500, though, a limit which has already been met with the opening of the Galaxy. Unlike Las Vegas, the Macau gaming industry gets more than 90% of its revenues from table games rather than slot machines. This is due in part to the large number of high rollers and in part to the different ratio of slots to tables, about 2.4 to 1 in Macau as opposed to 17.2 to 1 in Las Vegas.

Macau has emerged in the last five years as the world’s top gambling destination now, perhaps taking Las Vegas down a notch as it struggles with its own temporary oversupply of casinos and condos. The fortunes of Las Vegas may be more limited to domestic tourism in the future.

Luxury condos being marketed in Macau's Cotai South neighborhood

NEW SOUTH CHINA MALL: WORLD’S LARGEST FAILED MALL 新华南

2011-05-13T14:30:00.000-07:00

All photos were taken at about 1 pm on a Wednesday afternoon.

Having been an appraiser of distressed malls since 1984, I considered New South China Mall to be the Mount Everest of distressed malls. I finally got to "climb" this mall on May 11, 2011.

Completed in 2005, it is the world’s largest mall with leasable area of 7.1 million square feet, gross building area of 9.6 million square feet, space for 2350 stores, and a 99.5% vacancy rate.

What makes New South China Mall unique is that it has been mostly vacant in its 6 years since completion, and an inspection of the premises indicates that most of the few tenants this mall started with are now out of business. Press releases from the mall indicated that the mall had pre-leasing commitments from 1016 stores and opened with 386 stores.

New South China Mall was developed by an instant noodle billionaire, Hu Guirong, and financed with a billion-yuan loan ($154 million) from the Agricultural Bank of China, which was previously one of the Chinese government's "policy banks", banks that previously made loans based on government policy rather than on economic soundness. This was Mr. Hu's first retail development project.

The mall's feasibility was supported by a study from the SMR Group in Guangzhou, which forecast 203,973 customer visits per day based on the reasoning that building the largest mall in Guandong Province would attract shoppers from as far away as Guangzhou and Shenzhen. This is analogous to building the world's largest mall in Newark, New Jersey, and expecting shoppers to come from New York and Philadelphia.

While I'm not sure if Chinese market research firms have the requisite skills to perform such a study, most feasibility studies, whether in China or the U.S., are typically ordered by developers to justify an over-reaching project and are thus not designed to be objective, any way. (Most lenders are too cheap to order feasibility studies and assume, to their detriment, that the appraiser they hire will automatically determine feasibility for them.)

The Founder Group, a high-tech company created by Beijing University, recently acquired a 50% interest in this property.

People in photo are a janitor and a security guard

Here are some of the factors that have led to the mall's failure:

Demographics

The mall is situated in the city of Dongguan, 50 km south of Guangzhou and 90 km north of Shenzhen. There is no doubt that the Guangdong Province of China has experienced a population explosion, with the cities of Guangzhou, Dongguan and Shenzhen having a combined population of over 25 million residents.

Dongguan is a sprawling industrial city of 7 million residents and about 900 square miles of incorporated area, more than twice that of Los Angeles. Dongguan does not match the affluence of the cities of Shenzhen and Guangzhou, though. If Shenzhen and Guangzhou were New York and Philadelphia, for example, Dongguan would be Newark, comparing cities based on personal wealth. Annual GDP per capita is $13,750 in Guangzhou, $14,245 in Shenzhen, but only $8187 for Dongguan. Similar to Newark, too, is its reputation for a high crime rate compared to its neighbors.

Of Dongguan’s 7 million residents, 5.2 million are classified by the Government as “permanent migrants”, most of who are young women who have come from rural areas to work in factories – not the sort to hop into a BMW to search for a Louis Vuitton purse at the mall. Most do not have cars. It is estimated that 75% of these migrant workers earns less than $200 per month, and some of that is sent home to even poorer relatives.

Furthermore, the mall is located in the less affluent Wanjiang district of the city, where the factories seem to be low-tech, manufacturing things like cabinets and display shelves and using mostly unskilled labor. (This area was described as farmland at the beginning of the mall's construction in 2002 but is now a fully urbanized area.) Unlike typical U.S. urban form with dying central cities and middle class flight to the suburbs, China's urban central business districts are thriving centers of commerce, and suburbs are for factories and low income housing.

Also complicating mall feasibility is the generally low level of household income in China, estimated to range from one-tenth to one-sixth of U.S. household income, and the Chinese are known as being savers, too. Too much attention has been spent on the relatively small class of nouveau riche known for its conspicuous consumption. (See my blog on Macau.) Western-style malls are a recent arrival in China, and seem to work better in the wealthiest cities, such as Shanghai, than second-tier cities like Dongguan.

Despite Dongguan’s recent growth, there are now anecdotal reports that factory workers are leaving for better paying jobs in Shanghai and other high-value manufacturing cities to take advantage of China’s urban labor shortage.

"Strength-accumulating quietness"

Accessibility

Super-regional malls are dependent upon freeway accessibility. For instance, the 520-store Mall of America in Bloomington, Minnesota, is located near the junction of Interstate 494 and Minnesota State Highway 77. The 800-store West Edmonton Mall in Edmonton, Alberta, is located near the junction of the 2 and 216 freeways in Edmonton.

On the other hand, the highways leading to the New South China mall are tollways owned by Dongguan Development Company Ltd (not the government), with tolls ranging from 17 to 25 yuan (about $2.60 to $3.85 -- customary tolls for New York City drivers, but not for underpaid Chinese workers).

There seems to be a lack of convenient public transportation to the mall, too, considering that the mall is not in a central location and Dongguan itself is a sprawling city that has grown without the benefit of rational urban planning. With an area of 2500 square kilometers, most Dongguan residents would need to take multiple bus rides to get to the mall. Dongguan has grown without urban planning from 28 factory towns that ultimately grew into each other.

There is also an inter-city bus station with an entrance approximately 1000 yards or one km west of the mall's entrance, but no easy pedestrian access to the mall. Even then, inter-city bus fares are typically more than $15, once again too expensive for the average area resident.

To get to the mall, I took a train from Shenzhen to central Dongguan and then took a 55-km cab ride the rest of the way, having to also pay for the cab driver's 98 yuan in tolls (about $15) for the 110 km round trip. The drivers at the taxi stand all knew about the mall, yet my driver could not find the mall when on the same street and had to call the mall several times before the phone was answered. When a local taxi driver cannot find a mall that has been the world’s largest for the last 6 years, that mall is indeed in trouble.

Visibility

The mall site is mostly obscured from the main road by its high building profile (4 stories) and minimal signage. The cab driver and I almost passed the mall before realizing we had reached our destination, as the entrance, as seen in the satellite photo, is only about 100 yards wide. The only leased spaces were the ones visible from the main road through this 100-yard aperture.

No anchor tenants

There is no department store currently anchoring this mall, but the official mall web site states that the mall was originally supposed to be anchored by 1) a Causeway Bay department store of more than 400,000 square feet and 2) a KFC (?!). Other intended anchor tenants were OMOMO out of Hong Kong, OBI out of Germany, and Sundan Electronics. I do not know if these other stores opened or not.

In keeping with the mega-mall concepts of the Mall of America and the West Edmonton Mall, New South China Mall is situated around a miniature amusement park with children’s rides and canals with gondolas, like the Venetian in Las Vegas. At the time of my visit at 1 pm on a Wednesday afternoon, there were no shoppers, but several dozen school children in the amusement park. Out of about a dozen tenants, the three tenants doing business at that time were McDonald's, KFC, and Kungfu (a Chinese fast food restaurant with Bruce Lee as its emblem), all visible from the street and patronized by amusement park patrons.

The theme park concept was said to be inspired by the success of the Window of the World theme park in Shenzhen, but Window of the World is almost 20 years old and was the original theme park in Guangdong province, which now has 40 theme parks, 12 of which were bankrupt as of 2007.

Hark! A customer approaches McDonald's, the mall's leading tenant.

Other Functional Problems

I found it odd that there were no mall maps to be found in the world's largest mall. Any other Western mall one-twentieth its size would have maps.

I was also surprised to find myself trapped inside the mall, too, when trying to exit to the interior courtyard/theme park, which means that the shops are conversely just as inaccessible from the theme park. There are too few entrances to the enclosed shopping area. There were no shoppers or open stores in the enclosed areas I visited, and the entrance to the McDonalds was closed from the interior of the mall.

The design team for New South China Mall visited more than 100 malls worldwide to collect the best design ideas, but they apparently focused only on aesthetics and not on functionality or accessibility. It is an attractive setting, with re-creations of seven different parts of the world, such as Rome, Paris, and Amsterdam, but little thought was made to how customers would find the mall or move around in it once they got there. There is a replica of L'Arc de Triomphe, though.

Retail competition

Having previously lived in America’s most Chinese city for several years (Monterey Park, California – 56% Chinese) and traveled to many Chinese destinations, I have never known a Chinese community to be under-retailed (having a lack of stores); theirs is an entrepreneurial culture. The SMR Group's feasibility study assumed the trade area to be the entire Pearl River Delta (including the larger and wealthier cities of Guangzhou, Shenzhen and Hong Kong), assuming that building the world's largest mall would effective draw away customers from the 15 other super-regional malls (more than 1 million square feet) that were built in Guangzhou and Shenzhen between 2001 and 2003, most of which also suffer from high vacancies. Could New South China Mall be way more retail space than Dongguan needs?

The failure of New South China Mall is also symbolic of a fundamental disconnect between mall development and actual income levels throughout China as empty luxury shopping malls start cluttering the nation. Household incomes are still well below those of more developed Asian states such as Singapore, Hong Kong, Taiwan, Japan and South Korea. The recent decade of mega-mall development in China reflects a naive hubris that presumes that the biggest mall will therefore attract the most shoppers.

PS: For hilarious hyperbole and misuse of the English language, be sure to visit the mall's English language web site www.southchinamall.com.cn/english. The mall is described as "a pacemaker" (perhaps meaning "pace-setter", a pacemaker being the little machine that keeps former VP Dick Cheney's heart from stopping), and "a grand symphonic epic with high tone of traditional wealth revolution, investment revolution, consumption revolution and leading commercial trend of the time and vogue life style",..."highly hailed by experts, scholars, authoritative media and the society, as an international commercial empire". It even discloses that some Chinese economists were initially skeptical of the feasibility of the mall, but now "South China Mall has demonstrated its elegancy and glory, and is bound to be a miracle of commercial history." That was written a while ago. Now the mall is experiencing "strength-accumulating quietness" as the mall president, Kun Liu, has announced another 200,000 square meters (2,150,000 square feet) to be developed in an effort to somehow finally give the mall the critical mass it needs to compete against smaller malls (his opinion, not mine).

Oversupply hits Seoul CBD office market

2011-05-08T18:08:00.000-07:00

Left photo: The Center 1 "Mirae Asset" Towers

South Korean GDP growth was over 6% in 2010 and this country’s industries have become world leaders by copying and then rivaling Japanese industries. I was impressed, for instance, to see that half the cars and most taxis driven in Beijing are Hyundais. Because of its industrial prosperity, South Korea was until recently a preferred location for foreign real estate investors.

This is my third visit to Seoul in the last three years. In the previous two visits, I could not help but notice the Seoul skyline’s omnipresence of the construction crane, which I concluded had to be the new Korean national bird.

Local sources tell me that in recent office building sales, the trend seems to be “local sellers, foreign buyers”. The largest recent transaction in the Seoul CBD, for instance, was the sale of the SmartPlex building by Siwoo to Macquarie of Australia. Nevertheless, the local press reports that foreign buyers are even staying away or trying to sell what they have in the Seoul CBD (which seems to be less popular than the newer and fully occupied Gangnam office district south of the river, or even the Yeouido Business District on the west side). Merrill Lynch is reported to have sold half its stake in the newly completed Center 1 office tower (the one with Mirae Asset's name on the top), and Morgan Stanley struggled to sell the 35-year-old Seoul Square building which was once the headquarters of Daewoo.

CBD office space has been significantly increased by a wave of new properties this year. At the end of 2010, CBRE reported a local office vacancy rate of 9%, but with the addition of the new 168,000 square meter (1.8 million square feet) Center 1 office building (or Mirae Asset Tower) at the beginning of the year, the CBD vacancy rate is now in double digits, all this on top of negative absorption of about 375,000 square feet in the last reported quarter. There is also pressure from rival office districts south of the Han River, known as the Gangnam and Yeouido business districts, which offer lower rents.

One cannot help but notice significant new construction occurring one block east of Center 1 along Samil-daero, most notably the Signature Towers, two twin 17-story office buildings featuring 100,000 square meters (1,076,000 square feet) of new space.

New construction along Samil-daero, with the new Signature Towers across the street.

In the mean time, South Korea has been enduring a commercial property slump since the global financial crisis began. The overall default rate on project financing loans went from 4.39% at the end of 2008 to 12.86% at the end of 2010, and for savings banks in particular, the default rate soared to 25.1% at the end of last year.

Meanwhile, Korean investors seemed focused on acquiring overseas properties, with Samsung leading the way by hiring a Deutsche Bank subsidiary to spend the equivalent of $468 million to acquire "core real estate assets" in major European and American "gateway cities". In addition, The Korean Herald reports that Korean overseas real estate investment has quadrupled since one year ago, with $111 billion invested overseas just in March of this year, almost all of it being individual investor money rather than corporate money. At one recent meeting of Korean institutional real estate investors, the leading issue concerning overseas investing was not whether to do it but how to compensate for currency rate exchange risk. The Korean economic miracle has had the won rising against the dollar and the euro.

[Update, August 2011: Both Jones Lang LaSalle and CBRE now measure a CBD office vacancy rate between 12 and 13% and the Mirae Asset Tower is now reported to be 40% leased.]

Beijing housing shortage

2011-05-07T02:24:00.000-07:00

Beijing is one of those boom towns that suffers from a severely constricted housing supply, despite valiant state planning efforts. Whether in a centrally planned economy or an exclusively market-driven economy, though, this is a natural occurrence that comes from rapid economic growth. Rapid growth is hard to plan for, although China has been known to build residential communities in anticipation of growth, sometimes prematurely, such as the Zhengzhou New District.

The Government is encouraging both public and private housing development in an effort to solve the housing shortage. The “which is better, Communist or capitalist housing solutions?” debate was answered a generation ago by Deng Xiaoping, Mao’s second successor and architect of the modern Chinese economic miracle, who quoted a Szechwan proverb that it matters not whether a cat is black or white; if it can catch mice, then it is a good cat. This saying particularly resounds with me, as I have a black and white cat that catches numerous rodents, brings them into the house, and then forgets to kill them. Not a good cat.

"Chairman Meow" - Feline founder of a rodent "catch and release" program -- caught outdoors, then released into the Martin household. In debating communist vs. capitalist solutions to solve housing needs, Deng Xiaoping metaphorically said that it matters not whether a cat is black or white; if it can catch a mouse, it is a good cat. Deng was right about many things, but wrong about my cat. Yes, he is both black and white and ably catches mice, but misunderstands his duty to rid the house of rodents. Not a "good cat". Is this the face of a mouse-killer?

High housing prices and rents

A joint Wharton/National University of Singapore study found that housing prices increased by 225% in the last 8 years and Beijing land prices increased by 800%.

There are anecdotal reports that Beijing housing prices average 27 times annual household income. Unlike in the Western world, mortgage loans are limited to no more than 50% of value; nevertheless, additional leverage is often obtained from close relatives.

In an American city, housing prices at 27 times annual household income would be a precursor of a bubble waiting to burst, but only because American housing purchases have become highly leveraged investments in which the homeowner can quickly owe more than the house is worth, incentivizing the homeowner to walk away from his home via foreclosure, short sale, or deed in lieu of foreclosure. It’s harder for a Chinese homeowner to walk away from substantial equity or loan obligations to family members.

The Chinese housing model is less dependent upon leverage, while the family residence is considered to be the most secure asset a family can own. This environment also attracts speculators, which the Government continues to try to quell with new policies to curb housing price inflation, most recently tne "Eight National Measures" whose policies include 1) no bank financing for third home purchases, 2) minimum cash down payments of 30% for first home purchases and 60% for second home purchases, and 3) restricting home sales to only "registered residents".

The hukou system classifies citizens by their place of origin, thus limiting their mobility or restricting the right to services in the cities they move to. Preferential treatment is extended to "registered residents". It creates an almost apartheid system pitting rural vs. urban residents. The hukou system of classifying residents limits home purchases in cities with housing shortages to "registered residents" or "migrant residents" who can establish that they have lived and paid taxes in the city for at least 5 years. ("Migrant residents" have become marginalized similarly to illegal aliens in American and British societies.)

The sale of homes held less than 5 years is also taxed. The Central Bank has also raised bank reserve requirements 16 times over the last year and a half to rein in bank lending. Reserves are now required to be 21.5% of deposits.

Residential rental property investments are also priced very high, with sales prices reflecting annual gross rent multipliers exceeding 40 -- even higher than in Singapore or Hong Kong.

The China Daily reports a study by the Chinese Academy of Social Sciences that property prices in Beijing and Shanghai are 30 to 50% above market value. Their definition of market value obviously differs from that of other countries, as "market value" usually represents the price that a property would sell for under ordinary arm's length conditions, a definition commonly used in the U.S. The idea that everything is selling at above market value suggests a different definition of market value than held in the U.S.

With the Beijing housing shortage, the renter is in a particularly difficult position. One computer graphic designer explained to me that he pays about 70% of his monthly income on rent for his Beijing apartment, a rent equivalent to about $1000 USD per month, double what he was paying 5 years ago. He explains that recent college graduates often form groups of 6 or even 8 to rent one apartment, dividing the living room into individual living units.

Those who might consider Beijing housing prices to be a bubble, should take note that most bubbles collapse from falling demand or supply increases well in excess of demand, which so far does not seem to be occurring in Beijing. In American housing bubbles, one can observe that the most supply-constricted markets, such as Manhattan or San Francisco, suffer the least depreciation in economic downturns. One thing that prolongs the Chinese Bubble, too, is the lack of property taxes, which makes carrying costs low for real estate speculators. This is starting to change, now, with the cities of Shanghai and Chongqing instituting residential property taxes, with assessment rates ranging from .4% to 1.2%. This could curb speculation, although Chinese investors have few other choices of investments; Chinese stocks are considered riskier investments than housing and are down about 25% this year.

One interesting twist to the Chinese housing market is that all properties are leasehold. The residential land leases from the government are 70 years in length. As is customary with leasehold properties, improvements must be removed by the end of the lease. This creates interesting repercussions for the Chinese housing market. What happens to resale value after a few decades? Will family heirs have considerably diminished hereditary rights to housing? What resale values are possible for older homes nearing the end of their 70-year leases? It will be interesting to watch this grand housing experiment.

An answer to the overpopulation problem? -- from engrish.com

Fox Business interviews me about investor "fam tours"

2011-02-23T10:25:00.000-08:00

Photo of Riviera Maya beach featured on Pathfinder International fam tour

FoxBusiness.com did a story last Friday entitled "What You Need to Know Before Buying Foreign Property" and interviewed three sources, including me. The URL link is:

http://www.foxbusiness.com/personal-finance/2011/02/18/need-know-buying-foreign-property/

"Fam tours", short for "Familiarization tours", are sponsored, highly discounted travel for select individuals in order to promote interest in the host locations. They are most commonly offered to travel agents. Fam trips are also offered, though, to potential homebuyers and real estate investors, a phenomenon that I see happening worldwide.

As for fam tours for North American investors, I’ve recently seen the most activity in Costa Rica, Nicaragua, Belize and Mexico’s Riviera Maya south of Playa del Carmen (such as Tulum in the above photo). New highways and airports are making these regions suddenly more accessible to tourists, allowing residential development in areas previously considered too remote.

Vice versa, I have seen fam tours to the U.S. for Chinese investors seeking residential properties, something I discovered in my Asian travels last year. Unfortunately, some fam tours for Chinese investors seem to be focused on the most overbuilt vacation condo communities in the U.S., particularly the Florida Disney World market. Many of these condos are described as being “just 3 exits from Disney World”, encompassing thousands of newly built but unsold condos. I haven’t seen a more overbuilt vacation condo market within the U.S. This makes me skeptical about fam tours in general.

Africa is another place offering a growing number of fam tours for European investors. Ghana, for instance, is trying to attract European investors, while Gambia has been offering fam tours to Nigerian investors, creating some local controversy, as Gambians perceive Nigerians much the same way North Americans perceive them.

A healthy dose of skepticism needs to be exercised by anyone invited on a fam tour. In choosing among fam tours, I would suggest making the following choices:

Choose a fam tour organized by the local equivalent of a Realtors Association, as many different properties will be presented, as opposed to a fam tour operated by just one developer’s project. Nicaragua, for instance, has been offering such comprehensive fam tours in an effort to create awareness of Nicaragua as a viable vacation or retirement destination (as compared to Costa Rica next door). The more sponsors there are, the less your trip will feel like an abduction.
One dirty little secret of marketing vacation residences to foreigners is that many projects have not been built yet. They cannot get built without financing (which is where I get involved), and they cannot get financing without substantial presales accompanied by substantial cash deposits. The biggest discounts are offered on the unbuilt properties, but herein lies the greatest risk that the property may not ever get built. The deposits are often said to be “completely refundable” but may not be, and it is difficult for the foreign investors to negotiate the local legal system to get his or her money back; the “impartial escrow officers” can be the paid stooges of the real estate developers. One should choose a project that is already close to completion, as this will show the project is viable and that title should be clear.
The market for overseas or retirement residences was much stronger a few years ago, and many landowners have jumped on the bandwagon to offer luxury residences or residential lots for foreigners before they have even developed their land. Beware of a fam tour for a project that is unbuilt and has nothing more to show than artists’ renderings and a piece of raw land with a view of the ocean. Only a small fraction of these projects will ever be built, as the potential supply greatly exceeds demand. There is no shortage of raw land with pretty views in the developing countries of Latin America and the rest of the world.
Investors should choose fam tours that give them enough free time to “comparison shop”. Some fam tours are overscheduled to the point where the investor cannot get away to find better deals nearby. The fam tour may be to a destination where there are no rental cars available, but consider that real estate agents in that area may be willing to drive you to other properties, particularly completed properties. If you are already at a completed project, independent real estate agents can alert you to resale opportunities in the same development which may be available at lower prices. In Latin America, by the way, you can depend upon real estate agents to be fluent in English; many are former Americans.

Some fam tours may offer to reimburse airfare, but the fine print might say that the airfare will only be reimbursed if a real estate purchase is made. The fam tours I am familiar with, however, just offer a short stay for a discounted price, say $200 to $400 per person for a quality hotel and meals and transportation over a 3 or 4-day period.

For freeloaders who just want a discounted vacation trip, consider the loss of time and freedom while on the fam tour. Is it worth it? Have you ever been invited to a free breakfast in Hawaii in exchange for your attention to a 90-minute time-share sales presentation? Was it worth it? Only you, the reader, can truthfully answer this question for yourself.

Appraisal of the Leasehold Interest in an Australian Nursing Home

2011-01-24T09:38:00.000-08:00

I recently returned to Melbourne, Australia, to appraise yet another “aged care home” in a corporate portfolio of nursing homes and retirement villages seeking financing in the United States. The Australian and New Zealand banks won’t finance such property types any more due to a wave of failures in this industry in
2009.

The main problem with the Australian aged care industry is that it is highly dependent upon government subsidies which have not been increasing as fast as operating costs, the most notable cost being staffing costs. Unlike much of the “Western world”, Australia has escaped recession and suffers from labor shortages in certain industries, particularly the aged care industry, which has been limited in its ability to compete for nursing talent by low operating profit margins and inadequate government reimbursements. In this respect, Australia and the USA have a similar problem.

In this particular assignment, neither the borrower nor the lender informed me that the nursing home was leased rather than owned, a fact that only became evident to me after I ordered a title report on-line from the Victorian government (Melbourne is in the Australian state of Victoria).

There was some confusion due to some slight connotative differences in the definition of “leasehold interest” between Australia and the USA – two great nations separated by a common language (English). The Australians assumed that the US lender would lend on the value of their “going concern”, which in this case was the value of the nursing home business enterprise, the bed licenses, the FF&E (Furniture, Fixtures and Equipment) and the “Accommodation Bonds” collected from incoming residents. The American lender simply thought of the leasehold interest as that interest created by having a favorable (below-market) rental rate on leased premises. This difference in the connotation of “leasehold interest” created a vast gulf between borrower and lender in the perception of what constituted adequate security for a mortgage loan.

The nursing home was “built-to-suit” in 2009 and its rental rate was structured to be close to a market rental rate. The only aspect which created positive leasehold value was that part of the rent included a $900,000 lump sum payment in 2010, leaving less subsequent rent to be paid. At an annual rental rate of $8425 per bed in an industry where most aged care facilities are leased in the range of $10,000 to $13,000 per bed, there is a positive leasehold value. Nevertheless, there remains one more $900,000 lump sum payment that closes most of this leasehold value gap.

The borrower was quite emphatic about the value of more than $6 million in “accommodation bonds” collected so far from incoming residents, but such bonds are not “free money” but are liabilities that must eventually be repaid when the residents leave (either for the afterlife or else another facility). In the US one would naturally ask why such a liability could be considered an asset, but in fairness to the Australians, these bonds serve as interest-free loans in an economy where one can actually earn a decent rate of bank interest (6% +) in the mean time. In the US, bonded indebtedness is more likely to be treated as a shameful secret that only comes to light after I read the title report.

There are good reasons, though, why accommodation bonds can never serve as suitable collateral for a mortgage loan:

1. Aged care homes are allowed to commingle bond funds with their own business operations, as they may be spent immediately for debt reduction or capital improvements,

2. Bond proceeds can be immediately spent, and

3. Individual bondholders (residents) are in superior lien position to mortgagees.

If an aged care home fails, such as we saw in my previous blog about the Bridgewater facility in Roxburgh Park, the bond proceeds may disappear in the failure of the nursing home enterprise. The foreclosing lender has no access to the bonds, and even if the lender did, the money is owed to the residents. The Australian government has a reserve fund to pay back bondholders, but not mortgagees.

There is a value to the operator for the bed licenses, too, but licenses are tied to the operator, not the real estate, and can be withdrawn by the government, too, if the facility repeatedly fails to pass inspections, such as also was the case with the Bridgewater facility in Roxburgh Park. Last summer, for instance, I appraised a facility in Albany, Western Australia, in which the operator had previously stated the intention of moving bed licenses (and therefore patients) to another facility in town, thus potentially impairing the value of the proposed collateral. The lender could have been stuck with an empty, obsolete nursing home building.

During these past six months, I have read many aged care home and retirement village valuation reports from Australian “valuers” (the US equivalent of “appraisers”), and found all reports to be valuations of going concerns. This is appropriate methodology for corporate mergers and acquisitions, of which there have been quite a few in Australia, but inappropriate for lenders, who are left with few assets to take possession of in the event of a loan default. Nevertheless, these valuation reports were labeled as being for “mortgage financing purposes”, a label I find to be dangerous.

I have seen similar types of appraisals in the USA of nursing homes and hospitals, and lender reliance on such appraisals can end up as a huge mistake. Foreclosed hospital real estate, for instance, typically gets sold for about 20% of the original “going concern” value, as by the time the loan defaults, the hospital license is lost and the facility has become vacant, and a lender cannot get a license to run a hospital. In fact, in my work with foreclosed hospitals in California and Michigan, I have never seen one become licensed again.

Obsolescence plays a big role in this.

I have witnessed a lot of muddled thinking about the valuation of nursing homes and hospitals in both countries which merits more discussion about the distinctions between real estate valuation methods and going concern valuation methods.

Title Problems and “Lack of Transparency” in Latin American real estate

2011-01-01T23:32:00.000-08:00

Ejido de Llano Largo, Acapulco

One reader commented to me about the lack of real estate market transparency in the Dominican Republic and particularly warned me about title problems. He referred me to his web site www.DominicanWatchdog.org which contains the following warnings about title issues:

"1. Before signing any contracts or paying any money you must use a trusted lawyer to make a "deep" local title search. It's not enough to check if the title is "Clean", the ownership history must also be investigated as there has been and still is a lot of fraud with titles in the Dominican Republic.

2. If you are buying land you must use an independent surveyor to re-measure the land and confirm the position (the lawyers know which one to use in the area). Do NOT buy any land with squatters on it and make sure that no squatters are moving into your land as it's impossible to remove them later on."

The US Department of State has issued its own warning about the DR:

"Real estate investments in the Dominican Republic require a high level of caution, as property rights are irregularly enforced and investors often encounter problems in receiving clear title to land. Consultation with an attorney is recommended before signing documents or closing on any real estate transactions. Real estate investments by U.S. citizens have been the subject of both legal and physical takeover attempts. Absentee landlords and absentee owners of undeveloped land are particularly vulnerable. Investors should seek solid property title and not just a “carta de constancia,” which is often confused by foreigners with a title. An official land registry measurement (also known as 'deslinde' or 'mensura catastral') is also desirable for the cautious overseas investor. Investors should also consider purchasing title insurance. Squatters, sometimes supported by governmental or non-governmental organizations, have invaded properties belonging to U.S. citizens, threatening violence and blocking the owners from entering their property."

Market transparency

A transparent market is a market where relevant information is fully and freely available to the public. Jones Lang LaSalle, a major international brokerage (and former employer), published a Global Real Estate Transparency Index 2010 ranking countries according to the transparency of their real estate markets. Canada (no. 2) and the United States (no. 6, impaired by numerous “nondisclosure states”) ranked high in transparency and led the western hemisphere, while the Dominican Republic ranked 77th out of 81 countries and ranked last in the western hemisphere. (This list is not necessarily comprehensive; I once had to turn down a valuation assignment in Liberia, Africa, which is not ranked and seems to suffer from title anarchy.)

Squatters and "land reform"

In countries like Peru and Brazil there are vast shantytowns (AKA “pueblos jovenes” in Peru and “favelas” in Brazil) that are illegally erected on private land and extraction of squatters can also be legally difficult, as it is in the Dominican Republic and Mexico. The DR has also recently had a problem with an influx of Haitian refugee squatters after the earthquake in 2010. As Latin America has finally shaken off fascist governments, the new reality is that democratically elected governments are often more sympathetic to squatters and their alleged rights.

The government of Mexico, in carrying out land reform after the Mexican Revolution, re-instituted an Aztec agrarian communal system of ownership called the “ejido” in which campesinos share ownership of a large tract of land, land which is usually expropriated from the previous owner. A resident of an ejido is known as an ejidatario. Ejido parcels in Mexico cannot be sold, mortgaged or rented. The Mexican Constitution of 1917 promised to restore ejidos, and the expropriation of land for ejidos began in 1934 and continued until 1991, when President Carlos Salinas abolished the practice in order to ratify NAFTA, as American companies did not want to build plants on land that could conceivably be expropriated.

Llano Largo, Acapulco

As an example of the title issues inherent in the ejido system, I once appraised a parcel of land within the city of Acapulco, a few hundred meters north of the Boulevard de las Naciones which bounds the prestigious Zona Diamante section of town. The evening before I was to meet the landowner, I hired three Mexican real estate agents, including one appraiser, to accompany me to the property and share their opinions. While present on site, we were soon approached by several peasants from a neighboring shantytown. They politely asked what our interest in the land was and then claimed that the land belonged to them as part of an “ejido” granted to them. That introduced the possibility of a title problem. What was further perplexing was that the government had placed a sign on the property declaring it to be a “Reserva Ecologica” (ecological preserve).

The next morning the landowner/loan applicant drove me to a parking lot on the Boulevard de las Naciones and then pointed to his property across a grassy field. “Why can’t we go to it?” I asked. He reluctantly drove me to the western edge of the property, the only accessible edge, and when we disembarked, we were immediately approached by ejidatarios. Instead of talking to them, the landowner immediately summoned me back into his truck and we drove off. He called the ejidatarios “squatters who will be removed soon.”

The landowner further damaged his credibility when he presented me with an “Uso de Suelo” (a document certifying the permitted land use) for another parcel instead, a parcel described as being right on the Boulevard de las Naciones.

The need to use attorneys and title insurers

It is essential to use an honest, local attorney that has been carefully vetted. Several years ago, for instance, a Venezuelan friend of mine sold his business in Houston in order to retire in Costa Rica. He selected a house/restaurant on a cliff and was guided through his purchase by a local Costa Rican attorney. Unfortunately, he did not buy title insurance and the attorney he hired was in league with the swindler who claimed to own the property. My friend lost his life savings and ended up having to sleep on other people’s couches.

Two American title companies, Stewart Title and First American, now offer title insurance in Latin America. Be sure to specifically ask for coverage against squatters, too, or you may face years of litigation in a foreign land.

An Asian Growth Story

2010-12-27T18:00:00.000-08:00

Could the construction crane be Singapore's new National Bird?

Orchard Road retail - Louis Vuitton, Giorgio Armani

Some readers may wonder if I see any particularly strong real estate markets during my travels, since I seem to so often be reporting bad news.

How about an Asian country that grew faster than China in 2010, with an unemployment rate of only 2%?

That country would be Singapore. Year 2010 GDP growth is now expected to measure 15% as the result of a manufacturing-led growth spurt in the latter half of the year, second in the world to Qatar. Strong population growth (estimated at 1.8% per year), fueled by the developed world’s most lenient immigration policies, is creating a housing shortage.

A recent joint survey by Price Waterhouse Coopers and the Urban Land Institute ranked Singapore as the top investment destination in Asia.

Singapore also has ambitions to be the “Switzerland of Asia”, and one recent bold move by the government has been to double the area allocated to the Financial District, where CBRE has reported the office vacancy rate falling to 6.7% after brisk expansion of financial and legal firms, including major investment banks. Singapore is already Southeast Asia’s regional banking center, but the doubling of size of its Financial District would make it equivalent in size to Hong Kong's. About 7 million square feet are scheduled to be added by 2015. So serious is Singapore about achieving banking supremacy in Asia that they have been holding job fairs in the U.S. and U.K. to recruit banking talent.

Singapore enjoys the commercial advantages of:

1. A large, world class airport
2. English as the official language
3. The world’s busiest port (as measured by shipping tonnage)
4. An efficient, business-friendly government lauded for the absence of corruption
5. An educated and truly multicultural labor force with ties to many disparate spheres of influence. The three largest ethnic groups in Singapore are the Chinese, the Malays/Indonesians and the Indians, enabling ties to some of the fastest growing economies of the world – China, India and the Middle East.
6. No capital gains tax (except on residences held less than 3 years)
7. No restrictions on foreign ownership of commercial real estate.

Real estate prices fell during the Global Financial Crisis of 2008, but residential prices have been rapidly increasing since the second quarter of 2009. The residential price index for the 3rd quarter of 2010 reflected a 22.9% increase since the same quarter a year before. For those who are tempted to speculate, though, the government’s Housing and Development Board has enacted measures to counteract a bubble from forming, such as:

1. The sale of ten major government land sites to residential developers, allowing an increase in residential supply
2. A 3% tax on properties held less than three years
3. Minimum cash down payments of 20% on second homes (when financed by government-regulated lenders) and the elimination of interest-only mortgage loans
4. Continued restrictions on foreign ownership of landed homes (as opposed to condos)
5. Non-renewal of financial assistance to real estate developers

As for multifamily investment and development opportunities, one must consider that the Housing and Development Board owns 81% of rental units in Singapore, and government policy has the potential to mute increasing housing prices, even during a housing shortage. The luxury rental market should be least affected by competition from the government, nevertheless, as is housing for expatriates and immigrants prevented from receiving government-subsidized housing (restricted to Singapore citizens or permanent residents). At today’s rich valuations, with gross annual rent multipliers of about 29, however, development would spell more opportunity than investing in existing properties. Such a high multiplier can only be sustained with ultra-low interest rates, and one cannot predict how long such low rates will continue to last.

On the commercial side, overbuilding is still a possible hazard. For instance, CBRE has reported steadily increasing "capital values" (a valuation-based average rather than a sales-based average, although one would expect valuations to be influenced by recent sales) in the office, industrial and retail sectors, although office and retail rents have declined since last year. Office rents have started to climb again, though, in response to low vacancies, while “prime” retail seems to still have a problem.

Valuations appear to be quite rich. With an average “capital value” of $5800 per square foot and average annual rent of $373 psf for “prime retail” space ($1 SGD = $.77 USD), notably the Orchard Road area of town, the indicated gross rent multiplier of 15.5 seems unsustainable in the face of falling rents. The reason for the falling rents seems to be overbuilding. According to CBRE. 1.7 million square feet of space was completed in the first three quarters of 2010, 39% of which was in the Orchard Road area, including the new TripleOne Somerset, 313@Somerset and the Mandarin Gallery. Other new malls in Singapore include City Square Mall, Iluma, Yew Tee Point, and Tampines 1.

The gross rent multiplier for Class A office is as even giddier 21.7. “Prime residential rental properties” are perhaps the most richly valued at the moment, though, with an average GRM of 29.5. As a point of reference, whenever I see market average GRMs pass 14 in the U.S., it is usually a precursor of a market correction. The down side of "real estate growth stories" is that pricing can become quite inflated by the onrush of new investors who expect property value appreciation to rescue them from low or even negative current returns.

That being said, I did not see vacancies in Singapore that would put this city-state at risk of soon becoming “The Next Dubai.” Nevertheless, buying at such inflated prices seems antithetical to the investment advice of such legends as Warren Buffet or Sir John Templeton, who famously stated "The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell."

Perhaps the most attractively valued sector at the moment is the industrial sector, where rents continue to increase and the GRM average is just 12.7. Manufacturing has led the way in the increase in GDP; leading industries are electronics, chemicals and biomedical products. The port itself creates substantial demand for warehouse space.

For those counting on continued 15% GDP growth, the forecast from Singaporean economists for 2011 is considerably more subdued – about 4 to 5%.

Appraisal in the Dominican Republic

2010-12-25T20:45:00.000-08:00

Beachfront with view of San Pedro de Macoris

The subject property was a 59-acre parcel of raw, waterfront land situated about 45 minutes east of the rapidly growing capital city of Santo Domingo, ten kilometers east of the upscale beach town of Juan Dolio and a couple of miles west of the grimier city of San Pedro de Macoris, an industrial port city remnant of the days when sugar refinement ruled the economy.

The Dominican economy is booming. Tourism has almost reached pre-recession levels and is increasing at a rate of about 5% per year. Demand is also strong for exports of sugar, tobacco, and gold.

The town of Juan Dolio has prospered as the result of a new highway linking it to Santo Domingo, allowing affluent professionals to actually live above a white sand beach while efficiently commuting half an hour to their jobs and enterprises in Santo Domingo, a city of four million residents. New residents in Juan Dolio are more likely to be locals than foreigners, who nevertheless also have a presence there.

This land was part of an overall 252-acre project that was entitled for two 30-story residential towers, a Greg Norman golf course and a marina, among other residential uses. The first phase of the project, consisting of 52 private villas (priced at about $1.75 million each) and the golf course, was under construction on the date of my visit. A marina, sewage treatment plant, and electrical generation plant have not started yet.

The land is owned by a partnership managed by the most successful developer of upscale residential communities in Juan Dolio, including several sold-out condo towers. They pioneered the concept of developing condo towers at the beaches of the DR (Dominican Republic), and have a track record of successful condo development.

When tasked with conducting a market value appraisal, of course, the present owner is not considered in the analysis. Most appraisers are directed by their professional associations or their governments (particularly the U.S. government) to estimate the market value of a property as if it was placed on the open market and someone else is buying it. For lending purposes, that makes sense, as the only scenario a lender needs to consider is the “what if we have to foreclose” scenario, in which the property would indeed be sold to someone other than the current owner. The lender can make exceptions for particularly strong borrowers, but the appraiser cannot.

As is often the case, the property owner ordered his own appraisal from a well-known appraisal firm, which in this case was CB Richard Ellis, who estimated a value of $25,625,000, or about $434,000 per acre, which seemed like quite a steep value for so much raw land outside of town, even if it did front the sea. The entitlements are formidable, but is the demand there? The town of Juan Dolio, 10 kilometers west, seems to be undergoing excessive high-rise condo construction, and at least two projects have already failed. Would likely buyers, who are more likely to be affluent professionals from Santo Domingo than foreigners, be willing to commute even further to live in a high-rise?

The actual setting was also slightly less than ideal. Most of the waterfront consisted of protected mangroves, and what little beach there is has been fouled by the mangroves, as can be seen in the above photo. Then there is the view of the decaying electrical plant in the city of San Pedro de Macoris, responsible for frequent electrical blackouts in the area. Of course, when Phase 1 of the project is complete with the golf course and the marina, the views will be much better, but I was hired to do an “as is” valuation.

The only comparable sale I could find subsequent to 2007 was an entitled waterfront parcel on the north shore (near the Playa Grande golf course) which sold this year for $40,000 per acre. The north shore is more dependent upon tourism, however, and not quite as accessible by highway. Nevertheless, I did find listings of other waterfront parcels, entitled and unentitled, at prices not much higher than that, including a 97-acre beachfront parcel ten minutes east of San Pedro with 250 meters of white sand beach, a coral reef, and a private river, situated next to the Bahia Principe La Romana resort, listed for sale at about $51,000 per acre. La Romana is the next major tourist city east of San Pedro.

In the end, I estimated a value substantially less than that of CBRE, whose analysis did not present any land sales subsequent to 2007 and reconciled higher priced listings without any discussion of utility availability or the likelihood that the sales price would be lower than the listing price. Then again, I was hired by the lender and not the property owner.

An amusing incident happened at the Santo Domingo airport on the way home. All flights bound for the U.S. are subject to secondary hand screening at the gate. Card tables are set up and security guards comb through all carry-on luggage. A young lady went through my luggage and then said "Shake your body".

That's just what I did, but I apparently misunderstood her accent. She then said, "No. I check your body" and then proceeded to pat me down.

It brought back a memory from another Latin American airport in which a woman chased after me shouting "Cher! Cher!" I didn't turn around because I have no interest in Cher and wish she would just retire like she keeps on promising to. Apparently the woman chasing me was a security guard needing to see the claim check for my luggage. "Sir, Sir" was what she meant to say.

Kuala Lumpur condo market

2010-12-09T09:46:00.000-08:00

The Oval

Suburban condos

The Malaysian economy has been prospering recently, and one particularly new area of development is the luxury condo market. New luxury condo projects in the works will set a new standard of luxury living in Kuala Lumpur, Malaysia’s largest city.

There are two sources of buyers of new luxury condos, the Malaysian nouveau riche and wealthy foreign retirees. Malaysia has been trying to attract wealthy retirees with its MM2H (Malaysia, My Second Home) visa program, established in 2002, which issues 10-year resident visas to persons meeting the following financial qualifications:

1. Offshore monthly income of no less than 10,000 ringgit (about $3200).
2. Bank account of > 350,000 riggit (about $110,000) for persons over 50 and 500,000 ringgit for persons under 50.
3. Maintaining a minimum Malaysian bank balance of 150,000 ringgit for persons over 50 and 300,000 ringgit for persons under 50.
4. A “Letter of Good Conduct” from the immigrant’s government (to keep out wealthy criminals).

Malaysia is not alone among Asian countries trying to attract wealthy retirees. Thailand got to an earlier start and Indonesia has been attracting foreigners to Bali. In addition, the number of new residents in the MM2H visa program has only amounted to about 1500 to 1600 per year recently. The national origin of the immigrants to Malaysia is somewhat different, though, as Malaysia has a special appeal to persons of Muslim faith as well as persons who speak English. In 2009, for instance, the nation providing the most new visa entrants was Iran. Immigrants from the UK are typically in second or third place. There are also incoming Bangladeshis, Indonesians, Singaporeans and Indians.

The Malaysia Star and CBRE have presented statistics that 24% of luxury condo buyers are foreigners and 76% are Malaysians, with luxury condos defined as being priced at above 800 Ringgit ($267) per square foot. The average luxury condo price is about 1.09 million ringgit ($360,000).

One interesting aspect of tourism in KL is the number of Middle Eastern visitors. Malaysia seems to be a preferred tropical paradise for them, sharing their Muslim faith while providing a lush change of scenery. Some Middle Eastern tourists come to experience rain, which is in abundance in KL (about 100 inches per year).

As with luxury condo development in other parts of the world, it is hard to gauge whether the anticipated demand will match the supply being developed. There is no data to determine the outcome of this new area of development. What condo foreclosure problem I could perceive, though, seemed to be limited to middle class suburbs becoming increasingly inaccessible to KL because of the growing traffic problem. The edge cities of Rawang to the north and Kajang to the south seem to have a number of condo foreclosure auctions, but these do not appear to be luxury condos, but condos built for middle class commuters to KL. These condo towers are similar in appearance to the high-rise towers one might find in Destin or Panama City Beach in Florida – high density living that seems out of place for the suburbs.

Notable projects in KL include The Oval Kuala Lumpur, a recently completed 140-unit high-rise tower withunit sizes of 3750 square feet and 7600 square feet, and starting prices of above $1 million. These towers are situated next to the 50-acre KL City Center park and near the famous Petronas Towers, formerly the world’s tallest building.

Another nearby project being heavily marketed is VerticasResidensi, a proposed 43-story residential tower which will have 423 units ranging from 1400 square feet to 4500 square feet in size. The setting is in the Golden Triangle area of the city, known for its numerous upscale shopping venues.

Another heavily advertised project is MyHabitat, which sold out its first phase and the non-premium units in its second phase, and is managed by Fairlane Hospitality, who will rent out units for owners. Prices start at about $350 psf (USD). These will be much smaller units ranging from 603 to 1141 square feet in size.

There are other towers under construction, too, and no shortage of billboards for proposed luxury condo towers waiting to be built. The scene is not unlike Las Vegas in 2005.

Appraisal in Saskatchewan

2010-10-22T10:04:00.000-07:00

The property consisted of 190 acres in northern Saskatchewan in a summer tourism area. The local topography is glacial moraine, similar to Minnesota and Wisconsin, and features thousands of small lakes. The largest lakes have attracted small villages of summer cottages, most of which are unoccupied during the long winters at this latitude (53 degrees north).

Despite the booming Saskatchewan economy, buoyed by increasing world demand for potash, oil, and wheat, northern Saskatchewan remains a sparsely populated, slow-growing region. The local "Rural Municipality" (the Saskatchewan equivalent of a county), for instance, was last measured as having only 846 residents, increasing at a rate of about 17 new residents per year.

These 190 acres were acquired in 2007 and 2008 with the intention of building another vacation home subdivision. Unlike other vacation home subdivisions in the area, though, this property is not situated on a large lake, but has several small lakes within. Its terrain is quite hilly.

As nearby subdivisions continue to struggle to sell lots, the developer made the decision to seek a zoning change to allow development of a high-density senior "care and wellness facility" (with assisted living) and multifamily housing (fourplexes). This change in plans from conventional residential development to a "care and wellness" facility reminded me of my last appraisal in Costa Rica (see March blog), as the decision to develop a care facility in a remote, rural location usually occurs as an afterthought when the developer runs out of viable options.

Successful assisted living facilities usually have most of the following attributes:

1. Close proximity to a hospital. (The subject property is 35 minutes away from the closest one, and winter road conditions can prolong the journey to the hospital.)

2. Flat terrain. Seniors in ALFs often have trouble walking, and hills, particularly ice-covered hills, can limit their mobility outside the care center building itself. (My own father lives in an ALF in New Hampshire.)

3. Close proximity to relatives and friends. (The subject property is 113 km north of Saskatoon, a city of 223,000, the presumed source of most of the new residents, and the local area is very sparsely populated -- 846 residents in the entire rural municipality.)

4. Desirable climate. That needs no further explanation. On the plane ride to Calgary, for instance, I met a senior couple from Alberta (next to Saskatchewan) who had just made an offer on a house in Las Vegas.

In other words, there seems to be no compelling reason for most seniors to relocate to remote northern Saskatchewan. Sending Granny to isolated north Saskatchewan, moreover, doesn't seem much kinder than the ancient Inuit custom of launching infirm seniors into the sea on ice floes.

One nice thing about appraising in Canada is the provincial land registry systems. Sales data can be obtained for free in Alberta, for a small fee in Saskatchewan, or for a higher fee in British Columbia from a private vendor, such as Landcor. Most legal descriptions are based on the TRS system (township-range-section), and can be easily located on maps.

My client was interested only in the "as is" value of the site. Searching within a nine-mile radius plus the local rural municipality, land sales in the last 18 months ranged from $200 to $1500 per acre, and there had been no land sales above $295,000. The requested loan amount was more than $10,000 per acre.

The developer had hired his own Canadian appraiser, who estimated the value at $20,000 per acre, but this value was predicated on several undisclosed "hypothetical conditions", such as the subject land being rezoned and legally subdivided, and able to sell out its lots. Current zoning only allows two to four dwellings on the entire 190 acres, though.

Unlike the U.S., Canada does not statutorily require an appraiser to estimate "as is" value or to disclose hypothetical conditions in the report, which can seriously impair the credibility of a Canadian appraisal report. That might be the reason I get sent so often to Canada.

More on Australia: Retirement Villages

2010-08-10T16:20:00.000-07:00

Included in the collateral for this mortgage loan application were two retirement villages in Western Australia.

Australian “Retirement villages” have no exact equivalent in the U.S. As multifamily properties, they physically resemble "active senior" retirement communities in the U.S., but rather than selling or leasing the residential units, the landlord trades long-term leasehold interests (20 years or more) to incoming aged residents for an interest-free loan of a substantial amount, to be repaid when the resident leaves. The developer/owner then collects: 1) reimbursements of operating expenses, 2) a deferred management fee equivalent to 4% per year up to a maximum of 20%, applied to the resale price collected by exiting residents (these numbers vary by state), and 3) a deferred charge equal to 1.5% per annum to place in a sinking fund for capital replacements, also collected when the tenant leaves.

Most of the income of these retirement villages consists of the collection of deferred management fees, which when applied to the sale of the leasehold interest to another incoming resident, allows the landlord to share in the property price appreciation.

The whole success of this property type with Australian institutional investors has been based on constant price inflation, which has been the norm for Western Australia, even until today, due to the booming mining industry in that state and Chinese demand for minerals. The ability to apply the deferred management fee to the outgoing price gives the landlord a chance to share in the capital appreciation of the individual unit.

What is less clear is how the system would work if the living units were to decrease in value (which is not currently the case). Would the landlord have to make up for resident loan shortfalls if the units are turned over at lower prices? The lease contracts I saw were not clear about this, and in asking why this problem was not dealt with in the contracts, the response suggested that such an event would never happen, that retirement village units would always go up in price, just as they have done until this day. (Remember when American investors talked like that?)

Of course, the closest equivalent to this retirement village concept in the US is the continuing care retirement community which takes large, upfront, refundable deposits. Unlike Western Australia, there are bankruptcies occurring in this industry in the U.S., the most notable one being Erickson. Such a scenario seems to be considered unthinkable in Australia. Am I being too jaded by my American experience?

Of more immediate concern to this industry, however, is a June 9th Draft Ruling from the Australian Taxation Office (equivalent to our IRS) which will require purchasers of retirement villages to pay 10% GST (Goods & Services Tax) on the interest-free loans from the village residents in addition to the tax already paid on the assets being purchased. Based on my calculations for these two properties, the additional tax would wipe out most of the owner's equity in these properties as retirement village buyers discount their purchase offers accordingly. It seems like a very unfair tax, but is consistent with ATO's aggressive new creation of taxes, such as the new 40% tax on mining profits.

Special thanks to those Australian experts who have guided me along the way, particularly Peter McMullen of Jones Lang LaSalle, John Martin of Australian Property Consultants in Perth, and once again Professor Matt Myers at the Royal Melbourne Institute of Technology.

Appraising aged care homes in Australia

2010-07-28T15:54:00.001-07:00

I'm currently working on a portfolio of aged care facilities (or nursing homes) in Australia. The loan applicant has presented me with valuations of these homes as "going concerns", whereas my client is predominantly a real estate collateral lender.

The going concern value of an aged care home includes:

1. the value of the real estate, both land and building
2. the value of the operating business, particularly the bed licenses.
3. the value of the F,F&E (fixtures, furnishings and equipment), and
4. the value of the accommodation bonds (which serve as interest-free loans to the landlord), paid by the incoming residents.

My client, a private lender, is primarily interested in what they can take possession of and sell within six months in the event of a foreclosure.

In the event of a loan default, it is unlikely that there is any business value left.
One of the facilities had previously gone bankrupt, and the bed licenses were revoked. Furthermore, in Australia, unlike the U.S., the bed licenses travel with the operator and are not tied to the real estate. In sum, business value cannot be considered as security for a mortgage loan for these nursing homes.

2 of the 3 homes were more than 30 years old. Thus, the FF&E was highly depreciated and would probably command minimal salvage value. FF&E also make poor collateral because it can disappear, either to freelance thieves or else carefully planned midnight relocations involving moving vans.

The accommodation bonds are not the possession of the care home operator but are actually interest-free loans from the incoming patients, to be paid back when the patient leaves, either for another home or else for the afterlife. The Australian valuer placed a value on these bonds for the interest that they can collect while held by the operator, but many aged care organizations treat these bonds strictly as a liability on their balance sheets. In the case of the bankrupt home mentioned above, which was the Bridgewater facility in Roxburgh Park, the accommodation bonds went missing after the facility failed. $8.5 million in funds vanished and cannot be located.

In the final analysis, then, I am judging that the only appropriate collateral for a mortgage loan secured by such facilities is the value of the real estate itself, which means that I may have to analyze these facilities as vacant (and one already is).

I will update the blog when I return to the U.S.

Appraisal in British Columbia

2010-05-31T20:43:00.000-07:00

These were two different land properties, a 6-acre parcel in the heart of the village of Valemount, a town of 1100 near the Canadian Rockies, and 124 acres several miles north of town along the main highway connecting Vancouver and Edmonton.

The land in town had been granted local entitlements to build 183 condos and 70,000 square feet of commercial space. No feasibility study had been done, but I was told that there was a waiting list of 250 for the condos, and substantial "verbal interest" for the commercial space (meaning no leases or letters of intent). The story was that Valemount would be "the next Canmore".

Canmore is an expensive vacation community about one hour's driving distance west of Calgary and is the first town east of Banff, Alberta's most famous ski destination. Having appraised in Alberta in January 2008, I became aware how flat and boring and desolate the winter landscape near Calgary and Edmonton could be, and I learned that Albertans love to get away in the winter, whether to ski slopes in the Rockies or to warmer destinations, particularly Arizona.

Valemount, on the other hand, is about 300 miles west of Edmonton on the western side of the Rockies. This local area had gorgeous views of mountain ranges to the east, north and west, but was most noted for snowmobiling. Even Canmore is closer to Edmonton than Valemount, though.

The condo flats were priced quite steeply, from $430 to $455 psf Canadian, with prices ranging from $350,000 to $680,000, in one high density building. The strange thing about the waiting list, though, was that it was just a collection of names and addresses of people who had responded to ads, and there had been no discussion of prices, nor had there been any contracts signed. The ads had been placed in snowmobile magazines and had been aimed at middle class buyers. Valemount is a town, though, where one can buy 21st century homes on their own lots for less than $270,000. Per Landcor, the data service I use in BC, the highest priced home sale in the last year had been at a price of just $225,000, a new log home of 1068 square feet on a conventional-sized city lot.

The 124 acres to the northwest were just raw land, but were surrounded on two sides by the Canadian National Railway and one side by the Yellowhead Highway. Although still agriculturally zoned, the intention was to develop these 124 acres into a vacation village, too. The highway and the railway may have lessened the tranquility of the setting, but at least the property was quite accessible. One concern I had, though, was the amount of dead vegetation on the property. Knowing that the property had been previously owned and used by the Canadian National Railway, there exists the possibility of environmental contamination. Many former railroad properties in the US, for instance, had been contaminated through years of washing out tank cars. Rail ties, too, were treated with arsenic to resist rot before being set in place. The photo demonstrates a mostly grey area of dead ground cover, punctuated by young pine trees.

Both properties had been acquired at the peak of the market in 2007, and in my last valuation assignment in BC a year ago, I noticed that the sale of vacation properties began to considerably diminish after 2007. Yet, in this situation, the developer had appraisals done by Canadian appraisers estimating land value several times as high as the acquisition price in 2007. It gives me the impression that the Canadian appraiser profession is policed even less effectively than in the U.S.

Appraisal in Costa Rica

2010-03-15T09:22:00.000-07:00

The property consisted of three parcels of raw land totaling 92 acres adjacent to a remote beach in Guanacaste, a northwestern province of Costa Rica. The owner wished to finance construction of a 5-star hotel, tourist hospital and wellness center. The owner had signed a management agreement one year ago with Barcelo Hotels, a Spanish-owned luxury hotel group with many existing hotels in Mexico and the Dominican Republic. There were Costa Rican appraisals estimating the combined property to be worth about $26 million “as is”.

Although written in Spanish, the Costa Rican appraisals seemed to contain too much hyperbole to be considered objective. For instance, what were described as 360 degree panoramic views were largely obscured by hills and protected mangroves. The appraisers also assumed that 25 kilometers of unpaved road leading to the project would soon be paved and they valued “protected” (unbuildable) land at 80% of the value of buildable land. (Twenty percent would be a more reasonable number, since nature preserves do add some incremental value to adjacent development land.)

The owners claimed to have full entitlements to build the project, but the submitted documents only indicated approval to build 12 seven-story condominium towers on one of the three parcels, and these approvals were from 2007. The owner had decided to turn the condo towers into hotel rooms, without creating architectural drawings or plans, and there was no documentation that a development plan for a hospital and wellness center was even under consideration by local authorities. There were no drawings, plans or specifications for the revised development plan, other than a generalizd aerial view of the proposed project. The only site work had been to drill two authorized wells.

There were factors that caused great doubts about feasibility, the first of which was the lack of paved road access. The closest paved roads were in Santa Cruz, 25 km away, and the 6-month rainy season and rugged topography of this region can make road travel difficult, as roads are occasionally flooded during the rainy season. Four wheel drive vehicles are needed for half of the year. This is not a good setting for a 5-star hotel, but for a hospital, the setting was particularly doubtful. Successful tourist hospitals are typically located near airports, indicating that accessibility is a strong selection criterion of a hospital. The notable tourist hospitals in Costa Rica are CIMA, Clinica Biblica and La Catolica, located in the capital of San Jose, and the first two are already developing similar facilities near the Daniel Oduber airport in Guanacaste, with La Catolica also considering a branch there.

The idea for this project is that the hospitals would specialize in cosmetic procedures and that patients had the choice of convalescing in a time-share wellness center or else in a room in a 5-star hotel. Get a face-lift, for instance, and spend a month recuperating while gazing at the ocean. Still, the concept of a hospital so far removed from paved roads seemed to be far-fetched. Imagine being sore from a tummy-tuck operation and then having to return to the airport over bumpy, gullied roads.

The other factors that made me believe that this was not a serious project were:

1. The property is listed for sale for $8,500,000, entitlements included.
2. The property was previously listed for sale in 2008 for $5,500,000 and marked sold.
3. The construction cost estimates were quite incomplete, as were designs, drawings, plans, and specifications.
4. The lack of housing in the area for hospital or hotel support staff.

Considering that the owner had originally conceived of condo towers and townhouses on his property, the change to hotel and hospital seemed like an afterthought. This was a parcel of land in search of a profitable use, not a hospital enterprise in search of an ideal location.

As in Mexico, comparable sales are hard to come by in Costa Rica. There is no rule that the sales price recorded has to be accurate, and there are other circumstances that induce sellers to record false prices. I turned to listings of entitled land and unentitled land to set a ceiling of value for the property, and there are getting to be more fully entitled projects put on the market today just as in U.S. beach communities, too. I found entitled projects priced as low as $20,000 per developable unit, and unentitled ocean-adjacent land in Guanacaste priced as low as $10,000 per acre. I valued the hotel parcel as entitled land and the other two parcels, with no proven entitlements, as unentitled land.

Unfortunately, when looking at lending opportunities in Latin America, I see too many deals like this one, with the property listed for sale at a fraction of the value estimated by local appraisers, with the owner meanwhile spinning a fanciful story of a world-class development project. Lender beware!

My observations about international real estate deals are essentially this:

The least desirable properties must travel the furthest to find buyers or lenders. Good real estate opportunities tend to get picked off by local investors and lenders.

Appraisal in Fiji

2010-02-21T15:59:00.000-08:00

The assignment was to appraise one square mile of swampy, beachfront land, as seen above, adjacent to one of the primary resort areas of Fiji, known as Denarau.

Nearby Sheraton Fiji Resort on Denarau Island

Denarau Island isn't actually an island, but merely a one square mile section of land separated by a river with only one bridge, guarded by security, thus effectively restricting access to all but vacationers and those who serve them.

Denarau is considered quite a successful development today, with 5 star resorts by Sheraton, Westin, Hilton, Wyndham and Sofitel, but according to Matt Myers, MAI, former professor of real estate at the University of the South Pacific, the first developer failed and it took the second developer about 20 years to turn this former mosquito-infested mangrove swamp into the resort paradise it is today.

One of the issues to consider in this appraisal assignment was that none of the appraised land was "fee simple" or "freehold". Only 8% of the total land area of Fiji is fee simple land. 88% of the land area is owned in common by indigenous Fijians, and is leased to prospective users by the Native Land Trust Board, typically for 99-year periods. (This is similar to landownership in the Hawaiian Islands, for instance.) The remaining 4% of Fiji’s land area is owned by the state and is known as “Crown Land”. It is also leased by the government to prospective users for 99-year lease terms. Freehold is the preferred form of ownership, but ground lease terms are not usually onerous, thus creating positive leasehold value for possessors of leasehold interests.

208 acres consisted of "crown leased" land with 97 years remaining on the lease, but another 53 acres were land that was "native leased" with less than a year remaining on the lease. There was no way that my lender client was going to accept such land as collateral, and I thus could not assign it value, with the leasehold interest expiring so soon.

A second complicating factor was the physical developability of the land itself, which had a high water table, making landfill necessary. Most of the site is heavily wooded, with mangrove being the main species near the beach. Mangrove swamp is expensive to deal with, for several reasons:

• Significant landfill would be required.
• Mangrove swamps produce dark sediments which foul beaches (see bottom photo), thus requiring the importation of new beach sand.
• Mangroves are a protected species and the government will require the developer to relocate the plants.
• Flood prevention measures would be needed (river dredging, etc.).

Utilities have not yet been extended to this part of Fiji, either.

The third complicating factor was economic. Tourism to Fiji has been affected by the recession, causing discounting of already existing hotel rooms in Denarau. Denarau is just 20 minutes away from the failed Momi Bay Resort that was originally to be managed by JW Marriott, and the other major Nadi-area resort development, Naisoso Island, appeared to be struggling.

As in the Barbados assignment, most of my market data came from local journalists or real estate brokers. (One thing I like about these former British Commonwealth nations is that people write well and abundantly). I tried to hire a local appraiser to help me, but I did not find one with the same sense of urgency that my client had.

Appraising in Fiji seemed much like appraising in the Caribbean. The two dominant industries are Tourism and Sugar, and the island is a former British colony. Tourist develoments are kept removed from native communities, and the government is pro-development, despite the frequent coups d'etat, which are never violent, nonetheless.

Fiji has considerable natural beauty and posh hotel resorts. I would highly recommend mosquito repellent if you go there; there are occasional outbreaks of Dengue Fever, which causes painful bone inflammation.

Next stop: Playa Azul, Guanacaste, Costa Rica.

Appraisal in Barbados

2010-01-17T20:33:00.000-08:00

How I Spent my Christmas Vacation

I got called on Dec. 17th with an intriguing appraisal assignment--the valuation of about 250 upland acres in Barbados with entitlements for a 5-star golf resort and 124 luxury villas.

Normally, such a project in a tropical upland location would be a long shot (in terms of feasibility), but this project had secured a hospitality contract with Banyan Tree Hotels and Resorts, known for their 5-star resorts in Asia, Mexico and the Middle East.

One of the international development trends of the last few years has been to pair luxury residential development with a 5-star hotel, a pairing that creates a value-enhancing synergy. The developer plans to use Banyan Tree's management to provide services to the villa owners, such as housekeeping and room service, so that they are not burdened with having to hire their own staff. Such a concept has great appeal to the rich, such as Simon Cowell and Sir Andrew Lloyd Webber, who have pre-purchased villas each worth over $20 million (USD) in another Barbados project to be managed by Ritz Carlton.

The photo shows the raised foundation of the hotel-to-be and pools for private villas which are carved out of the bedrock, which is a calcified coral, much like limestone.

I found real estate prices in Barbados to be higher than in any other Caribbean destination I've been to. There is a reason for that which goes back at least three decades. Barbados was the only Caribbean island to receive Concorde flights (the supersonic Lockheed SST). The flight from London took only 3.5hours, and for the busy, accomplished, British multi-millionaire, Barbados became the most convenient and preferred location. Since then, the Island has built an impressive industry catering to the super-rich, with world class golf courses, fine dining and luxury shopping. The week I was there, the following celebs were in town: Simon Cowell, Siena Miller and Gerard Butler.

There are two successful inland luxury residential developments in Barbados: the Royal Westmoreland, which has a world class golf course, and Sugar Hill, where Tony Blair resides, and which has a world class tennis resort. Both are not far from the beach, and Royal Westmoreland also has impressive ocean views from its upland location. Apes Hill is a new project farther inland and has recently completed a magnificent golf course and claims to have sold out lots in its first phase. One of the residents will be pop star Rihanna. No homes have been built yet, though, and there are rumors that the first phase has not actually sold out, with further development temporarily halted.

Barbados has not been isolated from the world's economic troubles, and has felt an impact from a decline in tourism of more than 10%. The leading source of tourists is the United Kingdom, which has suffered from an almost 25% decline in the value of the Pound relative to the Barbadian Dollar over the last two years. Whereas luxury residential development was considered a sure thing in Barbados not long ago, projects are now getting suspended. The Ritz Carlton project, for instance, shut down last February but is said to be reopening soon as a result of new ownership and a partnership with the Barbados government.

Other appraisers might ask how one goes about finding comparable sales data in a situation like this when Government offices were closed Christmas week. The appraiser profession in Barbados seems to be focused on individual residential properties, and the brokers on the big deals, such as Knight Frank and Saville's, seem more likely to be in London than in Barbados.

I used journalists and bloggers, who are in abundant supply in Barbados and write in English. Moreover, the press is more likely to write about high profile comparable sales than about run-of-the-mill properties. I also perused real estate listings of large, entitled, resort-quality parcels.

In any event, it appeared that entitled resort-quality land was being marked down close to about $100,000 USD per entitled unit (hotel or residence), although the most recent listing to hit the market, the shuttered North Point Surf Resort, is listed at $71,875 per unit, suggesting a free-falling market for resort development land.