Thursday, June 21, 2012

A More Critical Look at “Skyscraper Index” Theory

          Shanghai Financial District skyline April 2012 -- A harbinger of doom for China?
                        Cranes behind Aurora Tower are on China's future tallest buiilding.

My post on Shanghai merely touched the surface of the discussion and analysis that has taken place about this theory that the completion of new “world’s tallest buildings” tends to coincide with economic downturns. The explanatory hypothesis is that these new world’s tallest buildings are emblematic of the misallocation of capital that fuels commercial real estate bubbles as economic interests take a back seat to inflated egos.

While a similar theory was presented in the early 20th century and had proponents such as eminent urban geographer Homer Hoyt, it became a moot point with the Great Depression and World War II. No new “world’s tallest buildings” were being built between 1931 and 1970, until the spell was finally broken by the World Trade Center in New York.

 As I mentioned previously, the skyscraper index theory was re-introduced in 1999 in a paper with the tongue-in-cheek title of “The Skyscraper Index: Faulty Towers” by research director Andrew Lawrence of Dresdner Kleinwort Wasserstein in response to the Petronas Towers of Kuala Lumpur being completed right as Malaysia and neighbors Thailand and Indonesia were economically collapsing in the famed “Asian Contagion” of 1998.

 Scholarly Research

Some notable academic articles have been published since then to test this theory.

In 2005, Auburn University economist Mark Thornton published "Skyscrapers and Business Cycles" in The Quarterly Journal of Austrian Economics, which is not an Austrian publication, but the publication of a U.S. think tank that explores the libertarian, anti-Keynesian economic theories of such famous Austrian and Austrian-influenced economists as Ludwig von Mises, F.A. Hayek and Joseph Schumpeter.  Although Thornton found the skyscraper index to be less than perfect in predicting economic downturns, he stated “The ability of the index to predict economic collapse is surprising,” and considered it to work better than many other recession predictors commonly relied upon by economists.

In a 2010 article in the same journal, Greg Kaza referred to the Thornton article and added “The tallest or once-tallest buildings in 40 states were completed in NBER-identified contractions.” [National Bureau of Economic Research] Despite his opinion of a high correlation between the skyscraper index and economic contractions, he considered the skyscraper index as “not meant to be a predictor of either economic contraction or financial crisis” but “meant to be a powerful illustration” of the effects of “stimulation by the central bank and the resulting pattern of entrepreneurial error that is revealed in the aftermath.” This is a somewhat political statement, as Austrian School economists are no friends of activist central banks such as the Fed.

A contrary view on the reliability of the Skyscraper Index was taken by a team of Rutgers University economists in an article published last December, entitled “Skyscraper Height and the Business Cycle: International Times Series Evidence,” concluding that there was no correlation between business cycles and the development of new world’s tallest buildings.

One good point that they made early in the article is that the announcement of the construction of a new world’s tallest building usually occurs several years before it is completed, and they could find no correlation between such announcements and economic downturns. (Of course, most announced "world's tallest buildings" never get built; see photo below.)

                                One "world's tallest" that never happened -- The Chicago Spire

They then tried to correlate the date of the opening of the skyscraper with the nearest economic peaks and troughs as established by the NBER and could find no correlation.

One odd flaw of this article is that it refers to “international time series evidence” but uses U.S.-centric NBER data to measure economic peaks and troughs relating to business cycles. This would not be a problem for the time period in which “world’s tallest building” was a uniquely American phenomenon, but this American dominance ended with the Sears Tower in 1974. Their comparison of the opening of the Petronas Towers in Kuala Lumpur in 1999 to the U.S. economic peak in 2001 completely forgets that the Malaysian economy peaked in 1997 and went into an economic tailspin in the Asian Contagion of 1998. The U.S. economic peak is irrelevant in this case, and this oversight is surprising considering that Lawrence's re-introduction of skyscraper index theory in 1999 was inspired by the example of the Petronas Towers and the Asian Contagion.

The authors' repeated misspelling of Mark Thornton’s name (spelled as Thorton) causes one to also wonder how closely they read his work.

Their use of months as their unit of time measurement also introduces some statistical “noise” that might possibly obscure a real pattern. If one uses years as units of measurement instead, one can almost see the forest for the trees:

 Building               Opening date  Nearest economic peak in same nation

Pulitzer                   1890             1890
Manhattan Life       1894             1893
Park Row                1899             1899
Singer                     1908             1907
Met Life                  1910             1910
Woolworth              1913             1913                                                              
40 Wall                   1930             1929
Chrysler                  1930             1929
Empire State          1931             1929
Twin Towers          1970/72        1969
Sears Tower           1973             1973
Petronas                 1999             1997* (my change)
Taipei 101               2004             2008* (my change)
Burj Khalifa              2010             2008* (my change)

There seems to be a pattern defied only by Taipei 101. Have other readers noticed this, or am I just applying false significance to the data, like an astrologer would?

Enhanced by Zemanta

Tuesday, June 19, 2012

Academia and International Real Estate

A good appraiser should have a solid academic foundation as well as empirically derived knowledge.

I have seen appraisers who did not understand that overbuilding causes rents and occupancies to drop, as they had not taken a college course in microeconomics. Discounted cash flow analysis, likewise, is chiefly taught in collegiate business schools, as is a sophisticated understanding of the concept of risk as it relates to investors’ expected rates of return.

Conversely, I have seen the growth of an academic real estate intelligentsia who has never gotten its shoes dirty, publishing scholarly articles about the behavior of people they apparently have never spoken to.  This is not an indictment of the academic community as a whole, but expression of a concern about a direction I see the academic community moving in regarding the teaching of real estate and the publishing of articles in scholarly journals such as International Real Estate Review. Some of today’s scholars are failing to talk to real word participants in the real estate industry and failing to perform field work, yet it behooves a scholar to have a complete knowledge of what he is writing about and the ability to teach practical skills to tomorrow's real estate professionals.

I first noticed this trend about 10 years ago as I read scholarly research relating to loan default modeling.  Scholars, many of whom were foreigners, developed multivariate models which included “appraised value” as a supposedly accurate fact, yet my friends who were residential appraisers regularly told me of the relentless pressure to deliver inflated appraisals, particularly as the mortgage industry became increasingly dominated the third-party-originators (such as mortgage brokers).  No one in academia or Wall Street was talking to appraisers.  Assuming that appraised value is indeed a factual indicator of value is a dangerous assumption, and that applies to commercial appraisals, too. Just ask any appraiser.

I consider myself lucky to have had some excellent real estate professors such as William Brueggeman (SMU), Kerry Vandell (now at University of California Irvine by way of U of Wisconsin) and Richard Peiser (now at Harvard), scholars who also had experience working in or with the private sector and could meld both real-world and theoretical concepts into their instruction.  I also notice that some universities, such as the University of Southern California, have seasoned appraisers teach real estate valuation, Ph.D. not required.

I also see other faculties increasingly dominated by professors whose only previous experience was as foreign graduate students in this country, and I see little to indicate that they were working real estate practitioners in the countries they came from.  Foreign nationality could be an advantage if they were teaching courses in International Real Estate, but almost none of them teach such a course, as such a course is rarely offered in the United States.

I have recently read the articles of university professors modeling the behavior of real estate developers.  Developers are described as carefully considering the exact amount of demand for their product and building no more than necessary to satisfy that demand.  Who did these scholars talk to? 

That type of demand analysis is something I would have liked to have done when coming out of graduate school in 1984. I interviewed for jobs at four development companies in Dallas, including Trammell Crow, and the response I got each time was “We can get 100% financing for our project.  Why analyze?” Of course, this reflected the general craziness of the Texas banking industry in the 1980s, but my work still has me constantly meeting and even traveling with developers, sometimes sharing breakfast, lunch, drinks and dinner with them, and their desire for 100% financing still exists, except now they have to trick lenders into financing 100% of the project (which involves trying to trick the appraiser, too). Misrepresentations abound, such as:

We’ve already installed water and sewers.”

“We’re 90% pre-sold” (with many of the buyers being LLCs or friends with addresses in the developers’ same, distant home towns).

“Our final map will be approved by the County any day now” (or maybe it was rejected last month).

“We’ll be getting tax credits.”

“The City of Podunk has already approved $40 million in bond financing for us” (just wait until Podunk tries so sell such bonds).  Besides, bonds are liabilities which have to be paid back, and end-purchasers will just deduct their share of bonded indebtedness from their purchase offers.

Never has a developer told me, “My analyst told me to develop much less than allowed, based on his research.”  Few developers employ analysts. Developers generally develop to the limit of their entitlements.  If they are legally permitted to develop 100 homes on a site, they almost always will if it physically possible, even if the development is in phases, and I have seen this behavior outside the U.S., too, including Canada, Brazil, and Latin America. No developer has told me that he wanted to develop less than his entitlements.  That would mean having to ask for a smaller loan, and most everything in this business is done with “other people’s money”.

Are developers rational?  Hell, yes, but just not in the way the scholars see as rational. It's all about maximizing return on equity, which is best done by minimizing or even eliminating equity.

As a former, part-time University instructor, I have no hostility to the academic community, and I would like to extend an invitation to Academia to have a member accompany me (at University expense) on each international valuation assignment as a way of "putting heads together".  I have possible upcoming assignments in Germany (a 1 million square foot logistics center in Norderheine-Westfalen), Costa Rica (residential development projects), or Ecuador (prospective solar farms) but bear in mind that I typically travel on short notice.

Enhanced by Zemanta

Friday, June 15, 2012

Guide to the most popular International Appraiser posts

Google Blogger lets me know which posts are read the most.  By far the most popular post has been “New South China Mall: World’s Largest Failed Mall”, having 12,503 pageviews so far.  Readers seem fascinated by spectacular failures, and this post goes into detail about all the mistakes made in planning this empty 9 million square foot enclosed mall, self-described as being “anchored by a KFC” restaurant.  Go, Colonel.

In second place is “Costa Rican Teak Farms for Gringo Investors”.  I thought the scams were already well understood, but the marketing of teak farms to foreigners seems to be on the increase and this post has been a surprise to many readers who were contemplating such an investment.  I hope that I helped them to make better informed decisions.

In third place is my post on Macau.  Americans do not realize how far ahead of Las Vegas Macau is in the amount of gaming revenues, 4 times as high at the time of the post. High-rolling Chinese gamblers, some who are laundering ill-gotten gains, are the life blood of Macau’s gaming industry.

In 4th place is my “World Gaming Revenue Comparison” I wrote as a sequel to the piece on Macau, once I found that this was a heavily searched topic on Google. Particularly interesting is the rapid emergence of Singapore on the world gaming scene, closing in fast on Las Vegas in terms of gaming revenues.

In 5th place is my post on the Perennial China Retail Trust, an IPO that went public on the Singapore Exchange in the spring of 2011.  My position on this REIT was that it relied on questionable “independent valuations” and feasibility studies in its IPO and misled readers and analysts.  Initially priced at $1 SGD per share, it went public at 70 cents per share and has declined to 47.5 cents per share as of June 21, 2012, a 52.5% discount from its original valuation.  Meanwhile, their first completed mall was last reported a few months ago as having lost 40% of occupied area as tenants fail.
Enhanced by Zemanta

Tuesday, June 12, 2012

South African game farm values: A farm agent responds from the Waterberg

                                             Game ranch in the Waterberg

I had two posts last year about the decline in South African game farm values and openly wondered if farm buyers were scared off by the radical land expropriation rhetoric of Julius Malema, who was then President of the African National Congress Party’s Youth League, but has since been dismissed and disavowed by the ANC Party and President Jacob Zuma.  Malema specifically said:

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.”

Farm agent Marius Willemse, who is active in the Waterberg Province which I visited, has this to say:

"As I’m not a wannabe politician, I won’t dwell on the political utterances. The words do not reflect ruling party or government policy. The rule of law prevails in South Africa. It is therefore unfortunate that once said such statements can not be undone.

I’m also not an economist or sworn valuator; I’m a farm agent servicing the Waterberg and believe game farm prices are influenced by many more factors. No single factor ever full explains a market’s performance.

Property prices in South Africa are currently still depressed as in many other parts of the World. It is partly a reflection of the money and capital markets and a result of the global economic fall out.

Many of the Buffet, Branson and sheik types of this World are currently off fighting other battles and not investing in what in a lot of instances is recreational property.

This lower level of foreign investment has a knock on effect. Local farm owners aren’t able to sell and then immediately reinvest the proceeds in another property, driving prices higher.

Current pricing also expresses normal cyclical activity. We’ve had an excellent run with year-on-year farm price growth as high as 47.5 % in the second half of 2008 (FNB National Farm Valuations Index). The market is simply taking a breather and if it is in negative territory then this will also only last a while. Before we know it the cycle will once again repeat itself.

The Waterberg area is special. It is malaria free, scenic and game rich, wild Africa at its best. It is close to the Johannesburg international airport and the heartland of the South African economy. It is easily reachable on a four lane highway and the road to its centre, Vaalwater, is currently being rebuilt.

The area is slowly but surely getting its act together. It is now a UNESCO-recognised biosphere reserve and there is a growing collaborative approach to marketing the area as tourist destination.

I think that as soon as the global economic dust settles we will once again see very significant farm price growth in the Waterberg".

I hope I didn't previously present a false impression of South Africa as seething with racial strife. What I witnessed was quite the opposite.  My Afrikaaner hosts seemed proud of the progress, both social and economic, that their nation has made in the last two decades, and never had anything disrespectful to say about black people. While riding the freeways of Pretoria I saw many German luxury cars being driven by young black people, much like Atlanta, suggesting an inclusive economy which allows all races to prosper. The closest thing to a racial conflict I saw was when one of the hosts had an argument with a black meter maid "My taxes pay your salary!"
Enhanced by Zemanta