Saturday, May 14, 2011

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

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, according 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.

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.

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.

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Luxury condos being marketed in Macau's Cotai South neighborhood
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Friday, May 13, 2011


All photos were taken at about 1 pm on a Wednesday afternoon on a sunny day in May.

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 visit 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, and perhaps he thought that once he had mastered instant noodles that he could master anything.

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:

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 not officially measured), 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 post 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 widespread reports that factory workers are leaving for better paying jobs in Shanghai and other high-value manufacturing cities.

"Strength-accumulating quietness"

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. Dongguan has grown without urban planning from 28 factory towns that ultimately grew into each other. With an area of 2500 square kilometers, most Dongguan residents would need to take multiple bus rides to get to the mall.

There is also an inter-city bus station with an entrance approximately 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.

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 ever opened.

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 also 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 The mall is described as "a pacemaker" (perhaps meaning "pace-setter", a pacemaker being the little machine that keeps 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).

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Sunday, May 8, 2011

Oversupply hits Seoul CBD office market

 The Center 1 "Mirae Asset" Towers, May 2011

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 CB Richard Ellis now measure a CBD office vacancy rate between 12 and 13% and the Mirae Asset Tower is now reported to be 40% leased.]
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Saturday, May 7, 2011

Beijing housing shortage

Typical Danwei-type housing for middle classes

Luxury housing for upper classes

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 quoted a Szechuan proverb that it matters not whether a cat is black or white; if it can catch a mouse, it is a good cat. Deng may have been right about many things, but wrong about my cat. Both black and white and catches mice, but fails to kill them. Not "a good cat". Realistically -- 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

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Wednesday, February 23, 2011

Fox Business interviews Vernon Martin about investor "fam tours"

Photo of Riviera Maya beach featured on Pathfinder International fam tour 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:

"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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.

Monday, January 24, 2011

Appraisal of the Leasehold Interest in an Australian Nursing Home

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.
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Saturday, January 1, 2011

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

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 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.

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