Another appraisal in Puntarenas, Costa Rica

The subject property was unimproved, mountainous, ocean view land of about 160 acres, located on the Nicoya Peninsula. It has no utilities, paved road access or development entitlements.

A decade ago, ocean view land parcels were trading at much higher prices because of their value to real estate developers, as each had dreams of building luxury vacation or retirement communities for wealthy foreigners. This same situation prevailed throughout Mexico and the Caribbean, too.

The only problem with this vision is that Costa Rica, owing to its topography and coastlines, has tens of thousands of square miles of land with ocean views, and there aren’t enough homebuyers to take up all the possible lots, particularly when having to compete with many other tropical paradise nations. Partially completed subdivisions ended up competing with other partially completed subdivisions when the market went into decline in 2007, and other projects never moved forward due to the difficulty in receiving all the necessary permits.

The land development approval process can take years in Costa Rica, much like in California, and typically entails:

1. Approval by the “municipality” (similar to a U.S. county),

2. Approval by the national environmental agency, SETENA (Secretaria Tecnica Nacional Ambiental),

3. Approval of all architectural and engineering design by the Department of Professional Responsibility of the CFIA (Colegio Federado de Ingenieros y de Arquitectos) [Translated: the Federal College of Engineers and Architects], and

4. Approval from the Ministry of Health

Last time I was in Puntarenas, in 2012, it seemed that every ocean view parcel of land was for sale and nothing was selling. Little has changed since then, except that asking prices are slightly lower now. Many landowners can’t reduce their prices any more and pay back the debt they’ve taken on. A broker was able to supply one closed sale occurring at a price at only one third of the asking prices of nearby parcels, but no large development parcels have been acquired since 2007.

There are enough land parcels with development entitlements or paved road access or utilities that unimproved land like the subject has little chance in competing for buyers, except at highly discounted prices.

Latest appraisal in Bakken

This  appraisal assignment was of a proposed 35-acre business park in the Bakken area in North Dakota in one of the most active counties for drilling. The owner planned to build a hotel on this site, but wished to sell off 25 acres to other users. Having a hotel on site would be a good draw for a restaurant, for instance, or perhaps offices serving as regional headquarters for an oil or oil service company.

The city with jurisdiction over this site had granted a permit to build a 2-story hotel with 290,000 square feet of floor area with the belief that it would be a 110-room family-oriented hotel. The developer plans to build a 3-story, 400-room hotel. Like many community governments in the Bakken area, the city was rather unsophisticated, not realizing that 290,000 square feet could fit many more than 110 hotel rooms. Nevertheless, the city expressed a desire for a hotel that catered to families whereas the owner/developer is known as a developer of “man camps” – lodging for single oil workers – with small rooms appropriate for single occupants, not families.

Example of hotel operated as man camp by Target Logistics in Stanley, ND

The city’s prejudice against “man camps” and oil worker lodging is becoming common among community governments in the Bakken area. Williams County, generally considered as the locus of the North Dakota shale oil boom, with Williston as its county seat, has issued a moratorium on new man camps and RV parks, as has McKenzie County, with Watford City as its county seat. There is a shared perception that man camps demand extra law enforcement resources, as so many single, bored, lonely, uneducated men in their 20s and 30s increase the local crime rate in such categories as public drunkenness, disorderly conduct, assault and sexual assault. They are paid well, though, averaging about $32 per hour, with many taking advantage of double shifts and earning 6 figures, so theft and robbery is less of a problem.

Temporary worker housing that is needed but unwanted by many local governments

The Bakken area is known for shortages of real estate in certain categories, particularly housing and lodging, but one property type in abundance is raw land. Early successes with Bakken-area business parks have led to a proliferation of “me-too” business parks, often having not yet procured the permits or water necessary for development, listed for sale at inflated prices. The subject property seemed to be in this category. 

Another complicating factor is the recent drop in the price of oil, which closed at $57 per barrel on December 19th. It is estimated that 60% of Bakken’s shale oil wells are unprofitable at below $60 per barrel because of the expense of fracking technology. The cost to develop a new well, furthermore, is estimated to be as high as $85 per barrel. The number of drilling rigs in North Dakota is now 181, 16% below the peak of the shale oil boom.

The few commercial land sales which could be found were of single-user sites of half an acre or less, whereas there is a proliferation of large business parks with unsold lots. In this instance, I had to create a discounted cash flow model with an extended absorption period.

Mainland China Property REITs to Multiply

Boundary between Hong Kong, on left, and Shenzhen, China, on right, photographed from Ramada Hotel
 

I’ve just returned from a recent trip to China, where financial deregulation continues onward. The week I arrived, the Chinese government approved a figurative “Through Train” that links the Shanghai and Hong Kong stock exchanges. And the first two days saw a massive transfer of capital from Hong Kong to Shanghai, with little capital flowing in the reverse direction. Part of the reason is because Mainland China is still perceived as the place where the growth opportunities are, and the Chinese Yuan currency has steadily appreciated relative to the Hong Kong Dollar, which is statutorily fixed to the U.S. dollar. The continuing trade imbalance between China and the U.S. continues to propel the Chinese Yuan slowly higher relative to the Dollar.

In this continuing Chinese financial deregulation, international real estate investors should take note of the proposal to organize mainland Chinese properties into REITs to be traded starting next year on the Shanghai exchange, with assets of these REITs estimated to top $6 trillion by 2020. This is an effort to support “the ailing Chinese property industry”. The Chinese government is also admitting a slowing of the economy as they announce reductions in taxes in order to stimulate business.

But if what ails the Chinese property industry is overbuilding, attracting more investors does not solve the fundamental problems of the industry, which is in need of more tenants, not more investors. More investors just pushes asset prices upward without improving net operating income, thus driving yields down, such as in Shanghai, where current yields were once over 7% but are now less than 5%.

Such compression of yields gives the appearance of improving real estate markets even when fundamentals are not keeping pace. For instance, I blogged last year about a portfolio of southern California industrial and retail properties I monitored over 11 years and found an average decline of 17% in net operating income but and average value appreciation of 28% in the same time period.

It remains to be seen how today’s investors will react to the new possibilities of investing in Chinese REITs. Such REITs often offer the prospects of instant dividends by the use of earn-out arrangements funded in IPOs, which serve as a return of capital rather than as a return on capital. Perennial China Retail Trust is an example, initially stumbling badly in the Shenyang market before finishing more successful projects in Chengdu and Foshan. Initial investors who bought at the 70-cent IPO price saw the stock price plummet to 40 cents before recovering to today’s 54 cents per share. Those buyers at 40 cents, including some insiders, still received dividends from the earn-outs funded in the IPO and profited enormously with the earn-out dividends and partial recovery in the stock price. Buyers will need to scrutinize prospectuses for actual net operating income sufficient to fund the advertised dividends.

Meanwhile, a recent Cushman & Wakefield report shed light on where Mainland real estate capital is headed -- out of the country, to "mature markets", with the U.S. being the favorite destination and United Kingdom in second place, and Hong Kong and Singapore as the preferred destinations for real estate investments in Asia.

The Issue of Client Pressure on Valuation Results in International Appraisals

Costa Rican subdivision overlooking the Gulf of Nicoya

It has been almost 3 months now since I’ve done a foreign appraisal assignment, and there are a couple of reasons for this.

1. I’ve had a large increase in business in appraisals of domestic “solar farms” (photovoltaic energy generation) in the U.S. Southwest, and

2. Foreign appraisal assignments have been offered to me with “conditions” that would compromise the ethical code most appraisers follow, conditions which would require me to deceive lenders or the U.S. Internal Revenue Service.

Here are some situations:

1. An owner of a high-end condo on Grand Cayman Island was fishing for an appraiser who could guarantee that his condo was worth $2 million in every year that he has owned it since 2006. But the Caymans have had the same rise and fall as every other Caribbean condo market, and it would not seem reasonable to anyone, including the Internal Revenue Service, that it had been worth the same amount in every year since 2006. The fact that he did an e-mail broadcast of these appraisal conditions to other appraisers could also end up getting him into trouble with the IRS, who provides rewards to whistleblowers.

2. Developers of ocean view residential subdivisions in Brazil and Costa Rica wanted to me to provide current market value opinions on their subdivisions without having me visit their properties. Yes, I was already familiar with their subdivisions, but a determination of current market value requires me to know current market conditions in these respective localities, requiring that I visit and analyze competing subdivisions, too.

“Desktop appraisals” (appraisals done without a property inspection) have limited reliability for overseas properties and are not likely be taken seriously by lenders, either. I also need to see if amenities, such as the guardhouse, pools, recreational areas are operational and that infrastructural development is continuing.

Shelf corporations in international real estate transactions

Grand Cayman's famous Ugland House, the address of 19,000 corporations

Most readers know what shell companies are. Many offshore locations, such as British Virgin Islands, Cayman Islands, and Cyprus are known for harboring shell companies because of their privacy laws, and shell companies are sometimes used for illicit purposes, tax evasion and money laundering.

But wait! This Wyoming office building houses 60,000 corporations.






A “shelf corporation” is an aged shell company that has a multiyear history of being in business and may also have a credit history and bank account, but no other assets or income. Shelf corporations are created by third party vendors to sell to buyers seeking a misleading history of credit and longevity for their own new enterprises. These shelf corporations are offered for sale on the Internet. Just do a Google search of “shelf corporation for sale” and you will find many shelf corporations that are legally created in the U.S., in states such as Nevada, Wyoming and Delaware, which promise privacy, secrecy, and protection from litigation. Named directors of these corporations are often down-on-their-luck individuals who consented to sell their names just like they would sell their blood to blood banks.

There are legitimate uses for shelf corporations, too, such as the ability to rapidly start up a business in a state that has a lot of red tape for start-ups.

Since most of my work is for lenders, though, I see the seamier side of this business. If the lender has made a loan to a shell or shelf corporation, and the loan defaults, the lender ends up trying to recover their money from a corporation which has no assets, no income and no accounts receivable.

I am sometimes confronted with purchase contracts in which the seller or buyer, or both, are LLCs, shell corporations or shelf corporations, leaving me unable to judge whether the purchase is an arm’s length transaction (a sale to unrelated parties). As an appraiser, however, I can only estimate a value supported by market data, and if the transaction is not arm’s length, it will become obvious. Many other appraisers will try to “hit the purchase price”, any way, with strange selection of or adjustment to comparable sales.

Every state in the U.S. has either a Secretary of State office or Department of Corporations office from which one can obtain names of the principals of LLCs and corporations, and it is helpful in determining whether a purchase transaction is arm’s length (different names on each side of the transaction), unless those entities are located in Nevada, Wyoming or Delaware.

Working in the United Kingdom last year, I was thrilled with the functionality of the UK Companies House web site – one web site for all of the corporations in the UK, so much easier than working in the U.S. It provided addresses, directors’ names, and dates for and changes of company names or directors. It also allowed me to easily establish that the sale contract I was looking at was for the sale of the property from one shelf corporation to another shelf corporation sharing the same directors — in other words, a completely bogus transaction.

The ICIJ, International Consortium of Investigative Journalists, has been documenting known offshore shell companies and their addresses. If in doubt about an address, one can check it out on their web site, https://offshoreleaks.icij.org/ They also have a list of the nations having the most offshore shell companies, which is helpful in its own right. For instance, a few weeks ago I was looking at a deal in Mexico in which the developer was a company in Cyprus. Red flag. Cyprus is not known for its real estate developers, just its reputation as a haven for shell companies.

Clues that you’re dealing with a shell or shelf corporation include:

1. No web site.
2. The principals of the organization have only hotmail, gmail or yahoo e-mail addresses.
3. The web site is “Under construction”. Sometimes there is verbiage about “amazing things to happen”.
4. No present location for company staff.

For example, in a situation I encountered in 2012, in which a piece of raw desert land was being purchased for $1.6 million above the price it had been listed at for two years, the buyer claimed to be looking for a location to build a 100,000 square foot corporate headquarters building for an unknown high-tech company. They had a web site under construction with the words:

“Company is in stealth mode while we develop the team, the infrastructure and the technology. Details to follow in Fall 2011.”

The corporation had no current location. A search of LinkedIn showed about 4 employees scattered all over the country, hardly enough for a 100,000 square foot building. No plans, specifications or blueprints were presented for the building, only artists’ renderings.

When he was unable to show established business operations, the CEO then talked about “secret government contracts”. Suspecting that my client had not performed due diligence on this loan applicant, I ordered a simple $25 on-line background check on the CEO and found:

1. Two criminal convictions, one for check fraud
2. Two bankruptcies
3. Two legal judgments against him
4. No background in high technology, but a bachelor’s degree in political science.

I could go on and on, but I quickly came to the conclusion that his company did not exist and his lack of recent accomplishments suggested that he may have been the kind of person typically recruited as a “straw buyer” in a fake purchase scam. If you participate in certain LinkedIn real estate groups, for instance, you may sometimes see offers of up to $50,000 to participate as a front man in a commercial real estate purchase. This is called “nominee fraud” by the FBI.