Wednesday, July 20, 2011

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

Stuyvesant Town. 

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

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

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

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

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

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

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

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

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

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

Friday, July 8, 2011

The Beijing Gateway Plaza fraud controversy

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

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

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

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

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

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

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

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

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

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

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

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

Tin Lik is now contending that he was coerced into admitting fraud and making the HK$287,497,000 payment to the Trustees in his new lawsuit, which seeks to recover that payment.
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Monday, July 4, 2011

"Independent Valuation" Problems in Chinese Equity Offerings

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

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

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

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

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

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


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

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

Independent valuation of Sino-Forest (TRE.TO)

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

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

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

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

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

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

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

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

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

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

Independent valuation of Beijing Oriental Plaza (Hui Xian REIT)

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

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

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

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

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

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


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

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

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

Tuesday, June 28, 2011


Singapore's Marina Bay Sands Casino and Hotel

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

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

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

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

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

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

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

2017 update:
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Saturday, June 25, 2011

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

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

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

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

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

Credit Suisse and Cushman & Wakefield Appraisal are currently co-defendants in three class actions lawsuits, claiming over $10 billion, over the loan defaults of all 14 resorts, as follows:

  1. $8 billion alleged damages. Property owners v. lender and appraisal firm. Filed January 2010.
  2. $2 billion alleged damages. Borrower v. lender, appraisal firm and appraiser. Filed February 2012.
  3. $250 million alleged damages. . Hedge fund loan investors v. appraisal firm. Filed October 2011.
The plaintiffs in the first lawsuit contend that CS saddled the resorts with debts much higher than the underlying real estate values, thereby forcing bankruptcies that impaired the value of the real estate holdings of the individual residents. Such a loan is sometimes called a “predatory loan” and the scheme sometimes called “loan to own”. As a former banker, I find such a complaint to be hard to believe. Foreclosures are rarely profitable for banks.

Credit Suisse hired the appraisal firm Cushman & Wakefield to appraise each resort according to an unorthodox methodology named “Total Net Value,” which basically ignored the time value of money in estimating the present value of each of these resort developments. Such developments were going to take years to sell out, but future revenues were not discounted for time. The “total net value” (TNV) methodology was tantamount to creating discounted cash flow models with 0% discount rates. Its sole purpose seemed to be to inflate the appraised value and thus justify a higher loan amount.

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

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

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

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

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

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

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

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

The appraisal reports for CS were previously published on the Internet and contained standard disclosures, disclaimers and Assumptions and Limiting Conditions. The “intended use” was for loan underwriting and the “intended user” was CS. An appraiser reading these reports could reasonably infer that the appraised values were not labeled as or intended to represent market values. The first plaintiffs in this case would not normally be considered to have a claim based on privity [duty of care to the plaintiff], either. Nevertheless, the appraisal firm is still facing an $8 billion lawsuit after an unsuccessful motion to dismiss.

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

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

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

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

Sunday, June 19, 2011

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

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

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

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

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

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

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

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

Distribution of the Revaluation Surplus

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

Friday, June 10, 2011

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

After visiting vacant new malls in China, I was naturally intrigued to know the rationale behind this Chinese mall IPO on the Singapore Exchange, which was originally scheduled to go public in March 2011 but was then delayed until June 9th and priced 30% lower. The rationale may become more apparent by the end of this post.

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

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

Red Star Macalline has been successful in wealthy Chinese cities such as Shanghai (GDP per capita of $23,000); can it be successful in poorer cities such as Shenyang (GDP per capita of $9211)?

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

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

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

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

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

The remainder of the PCRT portfolio

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

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

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

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

The Feasibility Study

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

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

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

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

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

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

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

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

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

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

This would imply that a quadrupling of retail space in the neighborhood could be matched by a quadrupling of local retail spending within two years. Anyone who has completed Lesson 1 of Economics 101 would be skeptical of such a conclusion. The report lacks quantitative analysis of supply and demand, such as a forecast of local retail space absorption or vacancies, and this verbiage is similar to the positive feasibility studies done to justify failed projects in Las Vegas, Arizona and Florida.

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

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

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

The reason for an IPO outside China

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

The valuation [appraisal] report

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

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

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

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

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

How the sponsor benefits from the IPO

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

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

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

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

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

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

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

Disclosure: I have no short or long position in this stock.
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Wednesday, June 8, 2011

Fraud in International Real Estate Transactons

Ecological preserve represented as potential residential subdivision

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

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

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

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

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

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

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

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

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

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

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

Seller-ordered appraisal and feasibility reports

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

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

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

Pre-construction buying opportunities

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

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

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

U.S. properties marketed overseas

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

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

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

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

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

Why international real estate attracts fraud

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

Tuesday, June 7, 2011

Private Housing in Singapore: Choice Between Luxury or Squalor?

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

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

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

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

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

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

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

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

Low income housing

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

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

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

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

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

2. An underutilized "gay sauna" in Chinatown rented a block of private rooms to nonresident workers.

3. Truck containers, 18 men per container.
Photo credit: The Online Citizen

4. Basements.
Photo credit: The Online Citizen

Issues about housing affordability and the crowding caused by immigrants were hotly debated in the campaign leading up to the May 7th parliamentary elections. The ruling party, the PAP, nevertheless held on to its parliamentary majority, losing only one out of 82 contested seats. Nevertheless, it only won 60% of the vote, the lowest percentage since the founding of the Singaporean state in 1965. This is considered to reflect growing discontment among citizens about the growing number of foreigners, who cause congeston and take jobs, the growing wealth disparity between the haves and have-nots, and the inability of young citizens to afford housing nowadays.
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Friday, June 3, 2011

Costa Rican and Mexican appraisals

Condo development site in Cozumel, Mexico

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

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

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

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

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

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

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

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