Sunday, November 27, 2016

Appraising Vacation Home Subdivisions

New subdivision near San Pedro de Macaris, Dominican Republic
 
If you have read my previous posts, one common observation is that there continues to be a worldwide oversupply of uncompleted vacation home subdivisions, condo projects and proposed subdivisions whose developers continually search for lot buyers and financing. I get to visit some of them for my lender clients.

I sometimes fly thousands of miles to see a project, only to find a mangrove swamp, jungle forest, steep hillside or a sugar plantation.

Sometimes the developer has obtained development approvals, sometimes not. The development approvals can be valuable in areas of land scarcity, but more often I am driven into a wilderness with pretty views but awkward access and a lack of local services.

It is useful to remember that market value depends upon what can be sold, not necessarily what can be developed.

I also see the same developments marketed to consumers with unrealistic photos of bikini babes in infinity pools, colorful tropical birds, the smiling faces of the grateful local natives, and cocktails at the beach.

Sometimes appraisers and valuers are confronted with the task of evaluating pre-sales contracts for lots. Should these prices be considered as market value?

Here are some things to consider in analyzing the sales:

1. What percentage of lots are currently sold or pre-sold? If the subdivision contains 900 lots, but only 20 are sold, this would represent an oversupply situation in which lot prices would have to be discounted.

2. Where are the buyers coming from? If the developer is from Omaha and the buyers are, too, this is cause for suspicion. These might not be real buyers and real sales. Another cause for suspicion is if the buyers are LLCs (limited liability corporations).

3. Read the sales contracts. Is the transfer of ownership conditional upon improvements completed by the developer? How much cash down payment is required? In some cases it might be only 5%, but if buyers perceive that their property has decreased by more than 5%, they might default on their payments.

4. What has happened on the lots that have been sold? Have they been developed or are there For Sale signs on them?

5. Are there lots already listed for sale in the secondary market? Check brokers and ads.

6. What infrastructure (roads, utilities, promised amenities) has been completed?

The preferred method of valuing a subdivision is a discounted cash flow analysis commonly called “The Subdivision Method”, in which all revenues and expenses are forecasted over time and discounted at a market rate of return. Witnessing very low rates of absorption of lots, however, I presently discourage this method for most vacation home subdivisions.

Whenever possible, I look for actual sales of incomplete subdivisions. These can be very hard to find, however. If such properties are listed for sale, though, that is a good place to start before applying appropriate market-based adjustments.

Thursday, August 18, 2016

How Can Aggrieved Chinese EB-5 Investors Get Their Money Back?



Vine Street property in Cincinnati



According to Baidu Baike (a Chinese on-line encyclopedia), there were 5539 Chinese EB-5 investor lawsuits filed in U.S. courts just within the 18 months between February 2014 and August 2015, or more than 300 investor lawsuits per month. That’s a large number considering that only 10,000 EB-5 visas are allocated per year. 

In most cases, the Chinese investors are suing their own regional centers for fraud, embezzlement or mismanagement. Regional centers pool investors’ funds to develop real estate projects in most cases. Some were suing US Citizenship and Immigration Services for denial of their permanent visa applications, but with each denial, it was the regional center that failed to perform up to job creation expectations, which mainly require that each investor prove that he or she created at least 10 permanent jobs lasting up to 2 years.

For those investors who want their money back, navigating the U.S. Justice System can be tricky, as evidenced this week in a U.S. District Court for the Southern District of Ohio in the matter of Hu et al v. Chan et al.

Ten Chinese investors contributed $545,000 each to the Midwest EB-5 Regional Center based on false statements allegedly made by some defendants in the Private Placement Memorandum as well as in presentations made by some defendants in China. The job creation project was to renovate retail buildings on Vine Street in Cincinnati, Ohio in order to create a “restaurant row” consisting of 9 restaurants. Renovations started but never finished, and all of the Chinese investors’ money disappeared. The false statements in the PPM were that investors’ funds were guaranteed by the Ohio state government, that investors’ funds would be kept in escrow accounts and only released upon USCIS approval of an I-526 (conditional green card) for the investor, and that investors’ funds would be supplemented by bank loans and tax credit financing, none of which were true.

The lawsuit was dismissed “with prejudice” (preventing other suits on the matter) on August 16th by U.S. District Judge Sandra Beckwith on the grounds that the fraud claim lacked “sufficient particularity” as required by Rule 9(b) of the Federal Rules of Civil Procedure, stating “The complaint does not identify with any specificity the time, place, or identity of the speaker of the alleged false and misleading statements." This was a surprising ruling to me, given the falsehoods contained in the Private Placement Memorandum, which would seem to be prima facie proof of false and misleading statements, plus the fact that the investors lost all of their money and did not get green cards. The USCIS even terminated this regional center in February 2015 due to failure to create jobs and misuse of investor funds.

Rule 9(b) is as follows:
(b) FRAUD OR MISTAKE; CONDITIONS OF MIND. In alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally.

I should disclose that I am not an attorney and do not provide legal advice. I report this case as a cautionary tale to aggrieved foreign investors. One recommendation that comes to mind is to hire an experienced securities attorney who already knows these rules of procedure.

There has been a growing trend among attorneys to “just sue everyone”, but perhaps there is a lesson to be learned here, which is to document who said what, when, how and where so that guilt can properly be placed on the appropriate defendant without the complaint being dismissed.

The plaintiffs are still allowed to file suit in Ohio state courts, as this was a Federal court decision.

A reader may ask, “Who cares about Chinese millionaires?” Stereotypes abound of “princelings” and relatives of government officials who get sweetheart government contracts.

In the first three of my 5 trips to China, I brought a neighbor, a Chinese immigrant, to interpret for me. When I finally asked him how so many Chinese people became millionaires, his answer was disarmingly prosaic – “By investing in real estate”. Many who bought condos in Beijing and Shanghai 15 years ago are now millionaires on paper, but not necessarily in cash. The same can be said for most California millionaires. His mother, a seamstress in Shanghai, had also become wealthy that way.

Having obtained their wealth through real estate investment rather than entrepreneurial activity, such EB-5 applicants are naturally attracted to the regional center concept of gaining an EB-5 visa, which is to pool funds with other similar investors in order to develop real estate. About 90% of EB-5 visa applicants choose to invest in a regional center rather than starting their own business. They are not experienced businessmen.

Some Chinese EB-5 applicants are not truly wealthy people. There have been some hard luck stories where the investor had to mortgage his own home to raise the minimum $500,000 plus administrative costs investment. If that money is stolen by a crooked regional center, that can create desperate circumstances for the family, including foreclosure.

As a Certified Fraud Examiner, I try to help aggrieved investors find a solution. If you have been cheated by an EB-5 regional center, you may feel free to e-mail me about your complaint, and I can present some options to you at no cost, but I am not an attorney and cannot file a lawsuit for you. All I can do is catalog the bad players in the industry and notify authorities.

Friday, August 5, 2016

An Appraisal of a Commercial Property in Seoul, South Korea.





A wealthy Korean immigrant died in California and his will left a commercial property in Seoul solely to his only daughter, thereby disinheriting her brothers.  Two brothers traveled to Seoul to have a Korean court overturn the will and obtain partial interests in the building.  They succeeded.  The daughter, in turn, sued her brothers in California court for full ownership, as California Estate Law had been violated. She won.

My assignment was to review a translated Korean language appraisal that had been ordered by a Korean court, in order for me to figure out the damages her brothers had to pay her for stealing part of her inheritance, and testify to this in a California court.
I had been a speaker at a conference sponsored by the Korean Association of Property Appraisers in Seoul in 2008, and was familiar with some of their valuation methods and the differences there are with U.S. valuation methods.
Two differences are:
Land and improvements are valued separately.  This is similarly done in Germany and by U.S. tax assessors, and I’m finding it increasingly necessary in Los Angeles County, where land values are spiraling upwards, calling into question the highest and best uses of many older properties.

Because Seoul is built out and there is a lack of land sales, The Minister of Land, Transport and Maritime Affairs also compiles a “Officially Announced Price System”. I often find that such price announcement systems fail to keep pace with changing market conditions, especially if created by a government bureaucracy.
The Government's computer-generated land valuations are overly general, too.  Theoretically, the appraiser should adjust land values for accessibility, size, and developability. This appraiser made no adjustments.
In this case no adjustment was made for a 4-story. 7736 square foot building that had no road access (see photo).  It was situated on a 241.3 square meter (2597 square feet) lot in Jongno-gu, which is one of the wards that compose the central business district of Seoul. The building itself is situated behind and obscured by a taller building and thus had no street access or visibility.
The appraiser stated land value to be 12,210,000 Korean won per square meter, equivalent to $10,912 per square meter or more than $1000 per square foot.  I have seen such land valuations in Manhattan, and since Seoul is a city of 10.2 million people with twice the population density as New York, I did not immediately doubt such a figure.
Nevertheless, the zoning for the site allowed only one extra story of height, and the site was already fully covered.  Accessible only by alley way, there would have to be an assemblage of adjacent parcels if any type of redevelopment could be done, but this is done commonly in Seoul if 80% of property owners consent to join a "redevelopment union".
Although this building was classified as an office building, its employees were more likely to be employed as seamstresses than office workers.  The lack of vehicular access limited this property’s highest and best use. The size of the lot, less than 2600 square feet, was only about half the size of a typical residential lot, which is not conducive to high-density redevelopment, and the space between buildings was so tight that I could not get a photograph of the whole building in one frame.
To find comparable sales and listings I turned to the auction houses which publish details of their real estate auctions.  They typically publish the original reserve price, which is based on appraised value, and then subsequent reserve prices which are discounted by 20% each month until they attract bidders.  The subject property itself had failed to attract bidders at two auctions and the reserve price for the next auction is now set at 64% of appraised value.
In the end, the client was able to get compensation from her brothers based on the original Korean appraisal.

One hidden treasure in these alley ways off of the street are blocks of street markets and food stalls.






Thursday, July 28, 2016

Shameless Book Promotion

This week I received a $17.70 semiannual royalty check for my book, Fraud Prevention for Commercial Real Estate Valuation, published by the Appraisal Institute, which I have sometimes advertised in the sidebar of this blog over the last five years since its publication.  This royalty check is equivalent to the sale of about 3 books in the last six months.

If there was a New York Times “Worstseller List”, this book might be on it.  Last year’s royalties were equivalent to the sales of 18 books.

Now the Appraisal Institute is conducting a fire sale of my book, having reduced its price from $45 to $23, and $18 for Appraisal Institute members.  I suspect that they printed 1000 copies of my book and have a few hundred left to sell.

I admit that I have not properly promoted my book, mainly because I want readers to view my blog as an objective place to instruct and learn, and not a place to boast or hard-sell.  My expert witness practice thrives on credibility.

I know very little about the buyers of the book, but I have heard that the book is in the Cornell University Library, and the director of the MIT Center for Real Estate e-mailed me to compliment the book and to offer me free admission to the MIT World Real Estate Forum last May, which I accepted.  The knowledge that scholars are reading my book also encourages me to think that there is a new generation of real estate practitioners being better prepared than today’s generation for the seamy world of commercial real estate.

There is no book like it in real estate literature except for my previously self-published book, Lessons from Losses in Commercial Real Estate.  It is the opposite of the “Get Rich Quick in Real Estate” books you see at the bookstore; it is a book on how to prevent money from being lost in real estate.

One of the central precepts of the book consists of two words that are absent from other books on real estate or finance: People lie.

A typical appraisal assignment often involves mind games and factual errors from parties that have a vested interest in the results of the appraisal, such as owners, brokers, taxpayers, divorcing spouses, etc. What this book does is catalog all the deceptions I had seen over the first 27 years of my career and explain the due diligence needed to counteract the deceptions. I explain the conflicts of interest that exist. I finish the book with a fraud prevention checklist for real estate transactions.

One thing I learned when I began my appraisal career at global firm Jones Lang Wootton was that the farther a real estate deal had to travel for capital, the higher the risk of fraud, which makes international real estate valuation riskier than domestic valuation.  I worked in the JLW Houston office and remember twice receiving phone calls from JLW offices in Asia inquiring about Houston condo deals being marketed over there. I would visit these properties and find cheap construction and adult men loitering about on a work day. Once, when I arrived on the first day of the month, I found residents hovering around their mailboxes, waiting for their welfare checks, indicating that many of the condos were being rented to low income tenants.

The book is 120 pages long and is an easy read.  My mother and father even read it and understood it. But for those appraisers (or investors or lenders) who don’t have the patience or funds to read it, much of the advice can be condensed into 5 words uttered by two U.S. presidents. 

“Show me” – Harry Truman

For instance, if a developer claims to have his residential subdivision 70% presold, I ask “Show me the purchase contracts.”  In one of my previous posts, a Canadian developer had no presales, just expressions of interest recorded on her web site.  In domestic appraisal assignments, I sometimes see purchase contracts from LLCs and shell corporations from the developer’s home town hundreds of miles away from the property being built.  I view these with suspicion. When I started my private practice in 2006 I saw my best client wiped out by a condo development scam in which 95% of the contracts were not arm’s length.  The sale was either from the limited partnership to a partner or vice versa, but the sales were all at $500,000, well above true market value.

“Trust, but verify” – Ronald Reagan

I go to appraisal assignments with an open mind, and real estate developers tend to be likable, persuasive people.  They can feel like new friends. It’s often not until I get home that I complete my verification process and sometimes exclaim, “Wait a minute!  He:

1.      Doesn’t own the property or have a valid purchase contract.  A valid purchase contract needs to have the owner of record as the seller. Or

2.       Doesn’t have the entitlements he claims to have. Or

3.       Has the property listed for sale at much less than he claims the property is worth. Or

4.       Has been previously convicted or sued for mortgage fraud, embezzlement, etc. Or

5.       Is trying to finance a non-arm’s length, “pocket-to-pocket” transaction.

It disappoints me that so many appraisers and valuers have no interest in fraud prevention, instead trying to shield themselves from liability with lengthy Assumptions and Limiting Conditions.  For example, my book Fraud Prevention for Commercial Real Estate Valuation was based on my award-winning article in The Appraisal Journal in 2009, entitled “Preventing Fraud and Deception”.  It took six years to publish that article.  I submitted it three times to the TAJ review panel.  The first time it was submitted, it was rejected as inappropriate. The second and third times, the consensus of the review panel, consisting of practicing appraisers, was that appraisers are not responsible for fraud prevention, and publication of this article would set a dangerous precedent.

It was not until I presented the article to an international appraisers’ conference in Seoul, where the then-president of the Appraisal Institute, Wayne Pugh, was present, when he suggested that I submit the article to TAJ. I told him that I had already been rejected three times and that most of the editorial reviewers considered fraud prevention to not be an appraiser’s professional responsibility.  He responded, “But it is” and encouraged me to re-submit.  With his blessing, I finally got the article and the message published.

So, if you are an appraiser or valuer who cares about his or her clients, I strongly recommend this book. 

Sunday, July 24, 2016

Appraisal in Roatan, Honduras


The property was mostly raw, wooded, hillside land leading down to a beautiful, reef-protected, white sand beach, with a few existing apartments up the hill. Part of the shoreline was occupied by mangroves, which are a protected habitat in Honduras, much like most tropical countries. The idea was to build individual vacation rental residences. The surrounding area had tourist traffic, including cruise ships, scuba divers and snorkelers, a nearby dive shop and a luxurious dive resort. It was a nice setting for tourists, but a lot of site work had to be done.

I requested documentation of the property’s entitlements, i.e. what the developer has the legal right to build. Most of the documents I received were Solicitudes de permiso de construccion, which translates to “Request for Building Permit”, and there were three permit numbers assigned for structures which had already been built, including several condominiums in 2008. The rest of the solicitudes had no permit numbers assigned and were expired. In short, I saw nothing resembling an approved development plan. The developer had also changed his development goals since 2008.

When I stated that the appraisal might be more favorable with an approved development plan (typically called a “final map” in the USA), I received a development plan the next day, addressed that same day to the planning department for the municipality of Roatan. It was written in English and was very limited in detail, consisting of squares and lines on graph paper.

In the last year I have been meeting more and more “wannabe developers” who merely place squares or rectangles on a two-dimensional map, include some artist’s conceptual drawings and floor plans, and call it their “Development Plan”. What about the infrastructure, the provision and placement of underground utilities such as water and waste treatment, the excavation and movement of earth, the measures needed for erosion control or dust control, and the measures needed for environmental protection? Even the banana republics I work in have had rules that needed to be followed when building in an inhabited area, because what is built and how it is built has an impact on the neighbors and the environment. When I am unable to get plans and specifications and detailed construction drawings, how am I to determine if the development proposal is not just a hoax?

When I work with an experienced real estate developer, on the other hand, there is one point in the site visit in which I visit an office full of detailed construction drawings, surveys, third party reports, photographs of successful projects, development budgets, contractor’s estimates and laudatory newspaper clippings, including the press announcement that the project has been approved by all the required agencies. These documents take up a lot of space. If the development site is too far from his office, a developer may instead email a myriad of documents or place them in an on-line dropbox for me. On the other hand, an inexperienced developer (or a hoaxer) is more likely to ask me to meet him at Denny’s Restaurant and show me artist’s sketches.

There is also sometimes a misapprehension that raw hillside land with ocean views is more valuable than flat land. It is not, because of the costs of development. Developed lots with ocean views, on the other hand, are more valuable than lower lots without views and access to the beach.

This novice developer adamantly insisted on already having all necessary development approvals, but did not provide a relevant document on municipal letterhead in the only language legally recognized in Honduras, which is Spanish, nor did he provide construction plans and specifications and a budget. He called me a liar. He also mentioned having cousins in the Mafia. Does this mean that the International Appraiser will soon be “sleeping with the fishes”?

Sunday, May 22, 2016

The Growing Worldwide Glut of Luxury Condos



Pavilion Residences One and Two stand largely dark at night behind the successful Pavilion Shopping Mall in Kuala Lumpur's Golden Triangle, yet Phase 3 is now under construction and promises to be more luxurious, featuring serviced suites.  Were Phases 1 and 2 not good enough? Phase One is said to have been sold out to residents from 27 different nations, but few seem to live there.


In my travels in the last year I have witnessed an increasing supply of luxury residential condominium towers in cities such as New York, Boston, San Francisco, Las Vegas, Seattle, Vancouver, Beijing, Shanghai, Kuala Lumpur and my home city of Los Angeles.

In many instances, luxury condo purchases represent foreign flight capital from the upper classes of nations with changing political conditions.  South Americans, particularly Venezuelans, have been attracted to Miami, where a condo glut from 8 years ago has been fully absorbed, with new condo towers now in the works. Western Pacific Coast condos are often being bought by Chinese buyers who want to diversify their investments or feel that they lack safe investment options within China, and some who just want a safe place to store ill-gotten gains now that the Chinese government is cracking down on corruption. 

In many cases, the motivating decision to purchase a luxury condo is the relocation and preservation of capital into nations with secure property rights and stable political conditions, such as the U.S., Canada and the United Kingdom.  Under the present circumstances in Venezuela, for instance, how secure can a high-net-worth individual or family feel when there are riots in the streets and the government is socialist?

As Jonathan J. Miller, New York’s most quoted appraiser, says in the New York Times, “We’re building the equivalent of bank safe deposit boxes in the sky that buyers can put all their valuables in and rarely visit.” These absentee ownership residences become obvious in night-time skylines all over the world, where few interior lights are on in the evening (such as the Pavilion Towers in Kuala Lumpur in the top photo). When preservation of capital is their main motivation, they hesitate to rent such units out and prefer to keep them vacant.
 
Preservation of capital, though, should not be confused with return on capital.  Those buying luxury condos for rental income will be disappointed, as some of these cities do not have the high income professionals (e.g. Miami, Las Vegas, Vancouver, and Kuala Lumpur) to cover the carrying costs of such condos. I have seen similar disparities in Honolulu.  Tourist cities might be pleasant locations for second homes, but local incomes are generally low, as how much can the local population earn working in hotels, taxi cabs and restaurants?

For those investing for property price appreciation purposes, I fear that the world is running out of multi-millionaires to purchase the swelling inventory, and depreciation is becoming increasingly likely, eventually resulting in fire sale prices. 

What happens, too, when the home country political conditions improve, and the owners decide to repatriate their capital back to their homeland?  Who will purchase such condos at resale?  Chinese and Japanese investors, for instance, have a distinct preference for purchasing new residences, and resales of luxury residences are often marked down. (I remember when the Turnberry was the place to be in Las Vegas in 2008 and have seen considerable markdowns since then.)

The result can be tumbling condo prices, as was seen in Vancouver at the beginning of this century, when Hong Kong investors in Vancouver condos decided it was safe to return to Hong Kong, where the capitalist economy was booming, and then sold their condos in Vancouver.  Now the buyers in Vancouver are from Mainland China. 

The recent regime change in Argentina might similarly entice wealthy Argentineans to return home to a new pro-business climate now that the incompetent Fernandez dynasty of 13 years is gone.  Argentina’s new leader, Macri, made a favorable impression in a recent episode of Sixty Minutes.

Within China there has also been an overdevelopment of luxury condos, as evidenced in the accompanying chart presented by a Chinese government housing official at the MIT World Real Estate Forum last week. The vacancy rate in the luxury residences (defined as Tier 3) is increasing while there is a great need for more “Affordable Housing” (Tier 1).  One young man in Beijing told me of having to share a one bedroom apartment with 3 other graduating college classmates while searching for employment in a country which generates more than 7 million new college graduates per year.  When I attended the OPIE (Overseas Property and Immigration Exhibition) in Beijing two weeks ago, I noticed a luxury condo tower breaking ground next to my hotel, the Metropark Yuantong.

Tier 3 housing has sold well in Beijing, Shanghai, Guangzhou and Shenzhen, but not so well in lesser cities such as Xi'an, where a 27-story high-rise tower had to be recently demolished due to lack of occupancy and deterioration.
 
 
 
 
Tier 3 Condo Towers in Shanghai

For most of China’s recent history, investment options have been few for local residents, so many have bought condos as a way of saving money with hopes of capital appreciation in the future. Local bank savings accounts offer paltry interest rates, and the Chinese stock market is increasingly viewed with suspicion as Chinese corporations do not operate according to GAAP (Generally Accepted Accounting Principles), but by CRAP (Chinese Regularly Accepted Accounting Principles).