Tuesday, June 12, 2012

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

                                             Game ranch in the Waterberg

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

They (whites) have turned our land into game farms…We must take the land without paying. They took our land without paying. Once we agree they stole our land, we can agree they are criminals and must be treated as such.”

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

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

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

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

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

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

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

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

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

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

I hope I didn't previously present a false impression of South Africa as seething with racial strife. What I witnessed was quite the opposite.  My Afrikaaner hosts seemed proud of the progress, both social and economic, that their nation has made in the last two decades, and never had anything disrespectful to say about black people. While riding the freeways of Pretoria I saw many German luxury cars being driven by young black people, much like Atlanta, suggesting an inclusive economy which allows all races to prosper. The closest thing to a racial conflict I saw was when one of the hosts had an argument with a black meter maid "My taxes pay your salary!"
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Thursday, May 31, 2012

Tepotzotlan, Mexico, revisited: The Danger of Hypothetical Conditions in Appraisals

Maybe once a year I get feedback from a client such as this: “We hired an internationally famous brokerage firm to revalue the property you appraised and they estimated a value 15 times as high as yours. Explain yourself.”

Such was the case recently with my previous valuation of land at the periphery of Mexico City. The appraisers were from the Mexico City office of an international appraisal firm being sued for malpractice for billions of dollars in the U.S.

Presented with the new valuation report, I found the reasons for the difference in value to be obvious. The appraiser made an assumption that the property would be rezoned at 12 times its current allowed density, permitting development of 1206 dwellings on a 26-hectare site. Such an assumption would be labeled as a “hypothetical condition” in a U.S. appraisal report, but it wasn’t in this Mexican report. (The neighboring subdivision built 18 homes before going bankrupt.)

My client never instructed them to assume such a hypothetical condition. I wondered if the loan applicant instructed them to make such an assumption, although the loan applicant never asked me to. In discussing the zoning, I even asked him, “So the current zoning allows you to build 104 dwellings, right?” to which he responded, “Yes, but because of the topography we can only physically build 80 homes.” Forced into a conference call with the appraisers, two things became apparent:

1. The appraiser never met the borrower or owner of the property, but only the mortgage broker, who told the appraiser that the property was about to be rezoned.

2. Although three appraisers signed the report, including an MAI in Chicago, it was only the most junior appraiser who actually visited the property.

I had a similar situation earlier this year, in which a brokerage firm’s appraiser did her inspection of raw land in the Dominican Republic from a helicopter and photographed and described the wrong property, possibly due to being steered by the property owner. It almost seems that the major brokerage firms do not care about their valuation clients.

My hard money lender clients always instruct me to appraise “as is”. The municipality of Tepotzotlan issues “Certificates of Zoning Information”, and the position I made in the teleconference is that I appraise according to present Certificate of Zoning Information until a new Certificate of Zoning Information is issued. This particular client agreed, stating “Please don’t assume anything”.

This post is not meant to criticize Mexican appraisers, as the problem is the same in the USA. Appraisers are too quick to believe statements such as “we will be getting final subdivision approval any day now” or “the elevators will all be fixed tomorrow”. It places lenders at risk and the appraisers at risk of being sued. Also see my post on "professional responsibility".
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Tuesday, May 29, 2012

Appraisal of a Condo Project in Harlem

I normally limit posts on this blog to my international work, although 60% of my work is domestic. I do not expect most readers to be interested, though, in California trailer parks or failed residential subdivisions. Sure, there are some interesting stories to be told, as each trailer can have a story of human misery or else a meth lab waiting to explode, and the subdivision was a possible flipping fraud that contributed to a Utah bank failure. But if I wrote about these things I could no longer call this blog “International Appraiser”.

I do think that New York’s Harlem neighborhood is worth talking about, though, as it is world-famous and one of the brightest spots I have recently seen in the U.S. housing market. Harlem is a neighborhood in northern Manhattan with a tough reputation.

I was born in New York City. My father studied at Columbia University, next to Harlem, and one of my early childhood memories was often waking up in the middle of the night to find my mother staring out my bedroom window at the bus stop, waiting for my father to return home safely. She told me that gangs in Harlem had initiation rites that included shooting or maiming a white man. This was only a few years after West Side Story had become a hit Broadway musical.

Fast forward to year 2001, and that is when the world first got a glimpse of a Harlem renaissance. That was the year that former president Bill Clinton established his office on 125th Street in Harlem.

New York City has been blessed with a period of good government and good policing, and Harlem has become a neighborhood secure enough for anyone to live in. As I watched out my window at the Aloft by W Hotel in Harlem, I saw a rich diversity of residents, from poor to prosperous, black to white, all walking at night without fear or conflict. I walked by the famed Apollo Theater to find the sidewalk in front mobbed by camera-wielding tourists and a line of white people waiting to get into this historic Black theater. I dined at a French restaurant where there were many men in suits.

I recently appraised a failed condo project in Harlem. This was partially completed new construction, with the exterior façade already finished. The loan applicant in this instance was actually the foreclosing lender, a very entrepreneurial firm which had the staffing resources to complete the development of the project.

This was not a case, though, of Harlem being not yet ready for condos. There have been a number of condo projects already completed and sold out, including a large project across the street from the subject, where the last sale was a one bedroom condo selling for $365,000. A check of the MLS showed only 3 units for sale in this zip code, with prices starting at $329,000.

It should come as no surprise, though, that Harlem has become a seller’s market for condos. You can’t keep a good location down forever, and Harlem fits the urban geographer’s classic model of decay followed by renewal. Harlem is just a few minutes farther by subway from Midtown or Downtown jobs than the Upper East Side or Upper West Side, yet where else in Manhattan can one buy a new condo for $365,000? This is about half the price one would pay for a comparable-quality unit in one of Manhattan’s established white collar neighborhoods, and the shortage of affordable housing in Manhattan has been a constant complaint of middle class professionals working there.

The prevailing shortage of housing in Manhattan and Harlem’s gentrification and convenient location has thus created good residential development and investment opportunities.

PS: The construction loan was funded by Kennedy Funding of Englewood Cliffs, NJ.

Friday, May 18, 2012

The International Appraiser in the press – Germany, Costa Rica, Canada

In the March 2012 issue of Canadian Real Estate Magazine, reporter Sarah Megginson interviewed me for advice to Canadian investors about purchasing individual residences in the U.S. My comments were that the most satisfied Canadian buyers were the ones buying residences for their own use (typically winter vacation use) and to be careful to avoid “guaranteed rental income” scams for investment properties in poor or vacant neighborhoods of overbuilt cities in Nevada, Arizona and Florida.

German architectural magazine Detail published one of my many photos (see above) of the New South China Mall in Dongguan, China in their April 10th story, “Die 10 größten Shopping Center der Welt” (“The 10 largest shopping centers in the world”). My post on the New South China Mall continues to be my most read post. If you look to the right, there are thumbnails of my posts in rank order of weekly popularity, from top to bottom. Another popular post is "Costa Rican Teak Farms for Gringo Investors".

Tico Times, the English-speaking newspaper of Costa Rica, recently interviewed me for a story published today (May 18), entitled “Investors: Where’s Our Money?”, which discusses the litany of investor complaints against Tropical American Tree Farms, an American-owned company in Costa Rica that sold individual teak trees with “certificates of ownership” having no legal standing in Costa Rican courts, and because the company purports to sell “trees” rather than “investments”, it is not subject to securities regulators in Costa Rica or the U.S.
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Friday, April 27, 2012

Shenyang and PCRT update

As reported in the April 25th edition of Retail Traffic, “Shenyang, China was the most active market for new development [in the world] in 2011 with 10.76 million sq. ft. [1 million square meters] of new retail space completed.” CBRE ranked Shenyang as second in the world in retail construction last year, with 2.18 million more square meters under construction in 18 separate projects.

Shenyang is a city of 5.7 million residents and ranks as the 11th most populous “urban area” in China (“urban area” being the term most analogous to the western concept of “city”.)

What this means is that Shenyang has increased retail space at a more rapid pace than most other large Chinese cities, which are themselves no slackers in building malls. Yet GDP per capita (the predominantly used statistic since household incomes are not measured) is less than half that of Shanghai. I have not heard the story yet on why Shenyang should have significantly higher hopes than other Chinese cities.

I have visited and focused previously on Shenyang because of it contains the only operating assets in the portfolio of Perennial China Retail Trust. Shenyang seems particularly at risk of retail overdevelopment, particularly the Dadong district containing the Shenyang Longemont Asia Pacific City development. The 2011 Market Study suggested a quadrupling of shopping center space in this area. Moreover, PCRT is designed to enrich its sponsors regardless of the success of its properties (such as compensation based on valuations performed according to blatantly unrealistic "extraordinary assumptions" dictated to the valuers), and the normal feasibility study process was thus compromised. 

The PCRT share price began sinking in February, possibly as a result of unfavorable news of a 39% decline in occupancy at the Red Star Macalline Mall as of December 11 (which had opened at 91.8% occupancy but was down to 56% as of December). The report to shareholders acknowledges that Chinese government initiatives to cool down the housing market have had an adverse impact on the sale of home furnishings, thereby hurting the tenants of Red Star Macalline Mall. PCRT has reported that they have relocated remaining tenants into one half of the mall, while the other half of the mall will be re-tenanted with conventional retail tenants, thus competing with their own Longemont Mall next door.

One surprising claim, though, was that the slow leasing performance of the Longemont Mall was due to a 3-month delay in the opening of the mall until October due to fire department regulations. My visit occurred in September and was instigated by the news that the mall had opened on July 1st. Furthermore, DBS (one of the IPO underwriters) published a favorable report on PCRT on November 14, 2011, with the title "Perennial China Retail Trust - Execution on Track", also informing the readers that the mall had opened in July. They set a 12-month price target of 83 cents. I noticed that their cameras carefully avoided photographing any vacant space, though.

It should be understood that the property inspectors and independent valuers are the paid advocates of PCRT management, hence explaining the wildly optimistic price targets and valuations.

Last week, the share price popped from 49.5 cents to 52 cents on news of Kuok Khoon Hong, the founder of Wilmar, a palm oil company, raising his stake in PCRT to 16.9%, seen as a vote of confidence. The purchase was at a price of only 44.6 cents per share, though, by a purchasing consortium 49.5% owned by Wilmar and 20% owned by CEO Pua Seck Guan. There is no buy that happens without a sell, however, and it should very concerning that the seller was Shanghai Summit, the local development partner in the Shenyang PCRT properties, effectively reducing their ownership stake from 14.9% to 0. When the developer in charge of the project bails out like this, shouldn't investors be concerned, particularly at a price of 44.6 cents per share? When the co-owner with the most local knowledge bails out, that is never a good sign.

PCRT is currently at 52.5 cents per share, creating a 17.7% two-week gain for buyers Kuok and CEO Pua Seck Guan.

Meanwhile, the latest "independent valuation" valuation still valued the entire PCRT portfolio as of the end of 2011 as completed and leased to 95% occupancy. I don't know why such fiction is permitted in Singapore, but if such a valuation report had been published in the USA, this would invite a class action lawsuit from disgruntled investors.

Disclosures: None. I have no short or long position in this stock and have no plans to initiate such a position.
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Tuesday, April 17, 2012

Latin American Land Grabs from Absentee Owners

Squatter housing in Mexico

When performing market research in Latin America, I heavily consult broker web sites, some of which require me to identify myself and provide contact information.

As a result, I find my e-mail inbox filled each day with “Retire in Paradise” promotions, written with the same tired old marketing vernacular, frequent underlining, bolding and exclamation marks!!!, used to also peddle miracle weight loss or genital enlargement pills.

Included are elated testimonials from retirees living like kings on $800 per month, describing cheap, delicious local food, friendly locals and $10 visits to U.S.-trained doctors. There are no traffic jams, but one still has to drive slowly in order to avoid hitting one of the many unicorns jumping over rainbows. Then there is the exhortation to buy now, before prices go up, because Latin America is running out of land, and the Baby Boomers just started hitting age 65 last year.

So you make up your mind to buy a foreign property now for when you retire in 5 years. You go down there, find some run-down property or vacant land advertised at a bargain price, hire a local attorney to verify clear title, pay the money and then leave. Everything is OK, right?

What sometimes happens is that the absentee owner arrives five years later to find squatters living on the property. When you call the police to have the squatters removed from the property you rightfully own, you find out that squatters often have occupancy rights under various “adverse possession” or "prescriptive easement" laws meant to protect landless campesinos from homelessness and starvation.

Even the United States has adverse possession and prescriptive easement laws, which recently became problematic in several states, such as Colorado, Florida and Texas, where squatters have seized unoccupied homes and transfered title to themselves, including a case in which the owner was absent only because he was being treated for cancer in Houston, 250 miles away. "Adverse possession" is different than "prescriptive easement" in that it extinguishes title for the former owner,
and in most U.S. cases, the title has been transferred illegally, as the minimum period of occupancy required in any state is 7 years. That's somewhat irrelevant, though, in removing squatters, as even American state laws protect squatters' rights until the matter has been adjudicated.

This squatter problem may be a somewhat recent problem in Latin America, which was largely ruled by heartless fascist dictatorships 50 years ago, but has recently been experiencing a democratic renaissance. Democracies give poor people a voice, effecting legislation sympathetic to their interests, including adverse possession laws.

If taken to a court of law, who would be the more sympathetic party in front of a jury or a judge -- the barefoot campesino who just wants a place to raise his chickens? -- or the rich gringo who didn’t even live on the property, letting the space just go wasted?

On the other hand, adverse possession can sometimes be a scam organized by a wealthy land grabber. Consider the case of Sheldon Haseltine, an absentee UK investor with prime land next to Costa Rica’s finest marina. He found squatters on his land in 1998 and tried to have them legally removed. He later found a billboard advertising a Wyndham hotel to be built on his site. He found out that the campesinos had been paid to occupy his site by another wealthy landowner and even found a copy of the cancelled check to the campesinos, in the amount of 100 million colones (about $200,000). His litigation has now lasted 14 years.

How could adverse possession be avoided?

1. Buy in an already-gated community (not accepting the promise that it will be gated some day).
2. Try to get some type of title insurance to protect against adverse possession (not sure if this exists). Title insurers, please comment.
3. Buy only when ready to move in.
4. Do not necessarily believe that prices will be increasing in the near future. In most countries I visit, property prices have been decreasing. There may still be opportunities available at the time when you are ready to occupy or develop your foreign property.
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Friday, April 13, 2012

Shanghai's Lujiazui financial district and "Skyscraper Index Theory"

From left to right: Shanghai World Financial Center, Jin Mao Tower, and the intended 2073-foot Shanghai Tower under construction

The last three years has inspired debate about whether China is going through a real estate bubble. Prior to my first visit, I had read beforehand of 64 million vacant Chinese apartments and 50% office vacancy rates in Beijing and Shanghai. When I arrived in China, I did not see this, except for some vacant luxury retail malls in second-tier locations. Perhaps some of these vacancy estimates were inaccurate or even hyped to make China look foolish. Claims of 64 million vacant apartments seemed preposterous when urban Chinese people told me they couldn’t find an affordable one, but to bubble theorists I have found the following chart from Wendell Cox of NewGeography.com. (My undergraduate degree was in Geography.) If there is a surplus, it is in the construction of luxury housing, which has been built more rapidly than affordable housing.

In the most recent Jones Lang LaSalle global office space count, the picture became clearer about all that formerly vacant office space in Beijing and Shanghai – it has been leased. By JLL's measures, Shanghai and Beijing ranked first and third respectively in the global absorption of office space during 2011.

Focus on Shanghai

I recently visited the two tallest skyscrapers in Shanghai, side by side, the World Financial Center and the Jin Mao Tower, both exceeding 1300 feet in height. Both have Hyatt Hotels atop office towers each with over 75 floors of office space. The building directories both indicate almost no vacant floors.

Despite such apparent success, there has been a recent re-introduction of a “skyscraper index” theory that portends a coming recession that naturally occurs after a flurry of new “world’s tallest buildings”, a theory that has been recently re-introduced by Barclays Capital’s equity research team in Hong Kong. This theory is not meant to imply causation, but instead reasons that having so many “world’s tallest buildings” built at once is but one symptom of a significant misallocation of capital that creates asset bubbles and resultant crashes. The recently published Barclays paper points out that of the world’s skyscrapers under construction, 53% are situated in China, which will be expanding its stock of skyscrapers by 87% by year 2017.

The crane-dominated Lujiazui skyline. The trapezoidal hole at the top of the Shanghai World Financial Center is designed to reduce building sway from high winds at this 1600-foot altitude. The hole was originally designed as a circle by the Japanese developers, which was perceived unfavorably by older Chinese generations as symbolic of the "Rising Sun" emblem on the Japanese flag -- an offensive reminder of the Japanese occupation during the last century.

Origins of the "skyscraper index theory"

The “skyscraper index” theory appears to date back to a 1999 paper by Andrew Lawrence, research director for Dresdner Kleinwort Wasserstein, perhaps in response to the southeast Asian financial meltdown concurrent with the opening of the world’s new tallest buildings of the time – the Petronas Towers in Kuala Lumpur. The southeast Asian region was collapsing in debt much like the current Eurozone crisis.

Some empirical evidence consistent with the skyscraper index theory

Since the beginning of the 20th Century, there seem to be some interesting correlations.

The famous Panic of 1907 coincided with the construction of two new world’s tallest buildings in New York. The 612-foot Singer Building was completed in 1908 while the old Metropolitan Life Tower (not the one blocking Park Avenue) was completed in 1909 at a height of 700 feet. The one year Panic of 1907 led to an approximate 30% decline in business activity and the severe monetary contraction was the impetus for the creation of the Federal Reserve System.

The 791-foot Woolworth Building in New York was completed in 1913 during the two-year recession of 1913-1914 which saw an estimated 26% decline in business activity as well as a decline in personal incomes. The Woolworth Building was just one of many New York skyscrapers completed at that time.

It was not until 17 years later that three new world’s tallest buildings were completed in rapid succession – the 928-foot Bank of Manhattan Trust Building (40 Wall Street) in 1930, followed by the 1050-foot Chrysler Building later that year, followed by the 1250-foot Empire State Building completed in 1931, all while the nation was sinking into the Great Depression.

It was not until more than 40 years later that the records were shattered by the 1368-foot World Trade Center in New York, opening in 1973, and then the 1450-foot Sears Tower in Chicago, which opened in 1974 amidst the worst U.S. recession since the Great Depression. Interestingly enough, you will find no offices built between the years of 1974 and 1980 in almost any American CBD.

The world height record was not exceeded until 1998, with the opening of the 1483-foot Petronas Towers in Kuala Lumpur at a time when southeast Asia was in financial crisis.

One interesting exception to the skyscraper index theory is the opening of the 1671-foot Taipei 101 building in 2003. Economic disaster did not strike.

Last of all, there is the 2717-foot Burj Khalifa that opened in Dubai in 2010 at a time when Dubai was about to default on its sovereign debt and was rescued at the last moment by its UAE neighbors. Perhaps this is the most obvious example of misallocation of capital as this building still stands largely vacant.

What are the implications for Shanghai?

In 2007, the Shanghai World Financial Center was completed at a height of 1614 feet, exceeding the 1381-foot Jin Mao Tower next to it. More auspicious, however, is the adjacent construction of the Shanghai Tower, which will top out at 2073 feet, making it the world’s second tallest building.

It is interesting to observe that the adjacent Shanghai World Financial Center and Jin Mao towers are both fully occupied. Bubble naysayers can easily say, “Look. All that space got built and leased.” The Shanghai Tower could be a game-changer, though, according to the “skyscraper index” theory, as the bubble just got larger.

Thanks to reader Ms. Ng in Chicago for pointing out that the pavement near these skyscrapers, which were built on landfill, is actually buckling. This appears to be some ugly concrete patchwork.

Not to be outdone by Shanghai, the Greenland Financial Center under construction in the Chinese city of Wuhan is considering a redesign that will have it top out at 2087 feet. When towers are built to assuage civic egos or developer’s egos rather than meet financial measures, watch out – a bubble is in the making.

My own “L.A. freeway model” of real estate bubbles

Those of us who have had to commute to distant jobs in southern California spend a lot of time in freeway traffic and often find patterns to get to our destinations quicker. Here is one pattern I learned early on:

When traffic is moving smoothly on eight-lane freeways, one can drive fastest in the “fast lane”, the lane farthest left in societies where traffic moves on the right side of the road. However, when the volume of traffic reaches a certain saturation point, the fast lane is beset with the most sudden decelerations, causing cars behind to hit their brakes even harder, and the fast lane suddenly becomes the slowest lane. It is during these types of traffic conditions that I make the quickest progress by driving in the far right lane where traffic is entering or exiting.

Liken a fast-moving freeway lane to a fast-moving economy, and the point I make is this: the fastest growing economies experience the hardest landings, or “the most sudden decelerations”. I have witnessed it many times before – Texas in the 1980s, southern California in the early 1990s, and recent examples in Las Vegas, Phoenix and Florida. That is why I say, “Watch out, Shanghai.”

For other information or views on an impending Chinese real estate crash, check out www.Chinesecrash.com.
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Wednesday, April 11, 2012


Red Star Macalline Mall on Shanghai's northwest side, from which I took the featured interior photos

In recent posts concerning Perennial China Retail Trust, I have referred to this unique retail mall type, a mall that specializes exclusively in furniture and home furnishings to retail end-users in an attractive, upscale setting. This mall type benefits from the virtues of agglomeration similar to the success of “auto malls” in the U.S. The object is to attract the consumer wishing to make a one-stop shopping trip in furnishing a new home.
This is a property type not commonly available to retail consumers in the U.S. The closest aesthetic equivalent I can think of is Chicago’s Merchandise Mart, which serves as a wholesale showroom mall restricted to buyers from major retailers. What Red Star Macalline does is eliminate the middleman.

Red Star Macalline began as a furniture manufacturer and morphed into an innovator in the sales of home furnishings and design services within a retail mall concept, switching from being a tenant to being a landlord. Founded in the 1980s, Red Star Macalline opened its first malls in 1991 in and sales took off, crowding out the furniture retailing efforts of western furniture vendors not sufficiently attuned to the furniture shopping habits of Chinese consumers. At last count, there are now 100 Red Star Macalline Malls in China.
At a Red Star Macalline Mall, home furnishings shoppers can haggle with individual merchants and also arrange turn-key design services. This is a consumer behavior that Home Depot and La Maison were not sufficiently accustomed to, having had to close many stores in China, but Ikea keeps persevering, even building its own store adjacent to the Pudong Red Star Macalline mall, easily seen during the taxi ride into Shanghai from the airport.

Mona Lisa bedroom set. "Faux Baroque" is said to be the preferred interior decor for China's nouveau riche.

Still, such a duplicative and complementary unit mix is somewhat risky at a time when the Chinese government has been putting the brakes on home lending. Less homes sold means less furnishings sold, and the recent shareholders’ report from PCRT confirms that Shenyang Longemont Red Star Macalline Mall has had its occupancy slip from 92% to 56% for that very stated reason. Existing tenants will be consolidated in one part of the mall while a broader array of tenants will be solicited for the remainder of the mall in Shenyang.

While the Chinese government does not publish data on household incomes, the closest figure it uses to compare city wealth is GDP per capita. Shanghai leads the mainland (excluding Hong Kong, Macau and Mongolia) with $20,000 annual GDP per capita, while Shenyang has less than half, last reported as $9244 per capita.

Sofa alone is priced at over 16,000 RMB ($2500 USD)

The recent slowdown in U.S. housing had severe consequences for the home furnishings industry, with the bankruptcy of such major furniture brands as Levitz and Wickes. While the housing sales slowdown in China is government policy-induced rather than credit-induced, there may be the hope of a quicker turnaround in furniture sales if the government policy is reversed (loosening restrictions on financing and homebuying by investors and “migrants”). In the mean time, China Central Television reported that sales at some home furnishing malls in Beijing decreased by more than 30 percent year-on-year in early 2012. Some small companies were forced out of business.

Side note on the just-published PCRT shareholders’ report for the upcoming meeting

PCRT has been slightly more forthright recently in reporting “independent valuation” results, mentioning this time (in footnotes) that the CBRE valuation is actually based on the assumption that all properties are completed and fully leased. CBRE has even raised its valuation this time. But with Shenyang Red Star’s occupancy slipping so badly, what purpose does such a hypothetical valuation serve other than to mislead shareholders? Would Warren Buffett report to shareholders in such a manner? What is the main purpose of an “independent valuation” other than to be independent and uninfluenced by the very managers whose compensation will be determined by the valuation itself, as disclosed in the IPO?

More on Shanghai soon
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Friday, March 30, 2012

Some Thoughts about Appraiser/Valuer Responsibility

Unfinished construction of beach condos in Brazil

This month has witnessed a certain game-changing event for the U.S. commercial appraiser profession – the first FDIC lawsuit against commercial appraisers since the Savings and Loan crisis over 20 years ago. (For the 54% of readers who are outside the U.S., the FDIC is the Federal Deposit Insurance Corporation, a U.S. government entity that seizes insolvent banks and tries to resolve bad loans.) This lawsuit is a precursor of more to come, based on the numerous legal actions already taken against residential appraisers.

Two Michigan appraisers are being sued because they performed an “as is” valuation of a residential subdivision as if it was complete, when in actuality development had not yet started. This led to a loan loss that contributed to the failure of Michigan Heritage Bank.

One of the appraisers had previously appraised the proposed subdivision exactly as it was, a proposed subdivision, but the developer contacted the appraiser at a later date to tell her that the project was complete and that the subdivision needed to be appraised as complete. The appraiser did so without going to the property to verify completion.

Perhaps the appraiser was duped, or perhaps she was knowingly complicit in this misrepresentation by her client and thought that exculpatory clauses in her report protected her. A typical exculpatory clause might read like this:

No responsibility is assumed for accuracy of information furnished by the client.”

Such a clause is standard in just about any U.S. appraisal report, but is this not just an abdication of responsibility? This clause evidently did not work, because she now finds herself and her boss being sued by the U.S. government.

This misrepresentation of an unbuilt property as complete without proper disclosure is a violation of U.S. laws and USPAP (Uniform Standards of Professional Appraisal Practice), yet I have seen this practice commonly done in other countries such as Singapore and Canada and have commented on this in previous posts.

I was recently involved in a similar situation in which two other appraisal firms valued an 85-year old, multi-story warehouse building with the assumption that the elevators worked. "How were we supposed to know that the elevators didn't work?" (I like to push the buttons, but if I get the common excuse, "the elevator just broke yesterday", I ask for evidence of a current elevator inspection certificate.) My client, a direct lender, never instructed the appraisers to make this "extraordinary assumption" which turned the search for the true market value into a meaningless academic exercise--a hypothetical estimation of value "as if the elevators worked".

The standard of appraisal practice today seems to be to value each property as if nothing was wrong with it, and then declare this assumption to be a limiting condition of the valuation report. It reduces an appraiser's sense of "duty of care".  Why bother to determine if the property is a SuperFund site (U.S. list of properties requiring toxic cleanup or remediation) when you can just assume that it's clean.  Why bother to verify that utilities are available to the site when you can just assume so?

One central problem of the appraisal/valuer profession is the abdication of responsibility

Now that I have had the chance to read appraisal/valuation reports from every continent except Antarctica, I find abdication of personal responsibility to be endemic to the worldwide commercial appraiser/valuer profession, which causes me to propose the following manifesto:

1. An appraiser or valuer should care about all users of his report. Not only must he care about the welfare of his immediate client, but also about others who could rely on his report. An appraisal report done for a mortgage broker, for instance, may also be the basis for a lending decision from a direct lender who could lose money if the property is overvalued. If appraisers want to earn the same respect as doctors, we should be mindful of that part of the Hippocratic oath which proclaims “Do no harm”.

2. Accuracy, rather than report length, should be the primary goal of the appraisal process, as that is what contributes most to the soundness of decisions based on appraisals. In the North American commercial appraisal profession, too much emphasis is made on constructing lengthy reports full of canned comments and not enough emphasis is made on research and analysis. Some appraisers even purchase software that adds pages more of canned comments. Reports can do without paper-wasting, tree-killing comments like “Los Angeles is on the west coast of the United States of America in the western hemisphere of Earth, the third planet from the Sun.” I have also found myself perplexed in the past by appraisal instructor who have said "Your estimate of value doesn't matter. Only the report matters." Ask any client -- of course, the value matters!

3. Appraisers need to verify important facts about the property being appraised. Tenants should be verified as occupying the space they are said to be occupying. Representations about building area or land area should be verified by measurement or by public documents. Entitlements or planning approvals should be verified by recent official documents or better yet, by calling on the relevant public agencies. Relying on a property owner's statements without verification just invites fraud.

4. Whenever doubts arise, the appraiser should investigate or recommend investigation rather than make the extraordinary assumption that nothing is wrong. If the financial statements do not seem credible, he should request tax returns. If the ceilings are stained, he should look at the roof. If a subdivision is dependent upon well water, he should request a well water report. Assuming that nothing is wrong turns appraisals into meaningless academic exercises that lead to overvaluation.

When I was starting out in this profession in the 1980s, I had a mentor who would tell me to "stop agonizing" and just put down a number. I'm glad I didn't follow that advice. He eventually lost his license and company.  My clientele pays me to agonize.

The application of professional appraisal standards

Professional valuation standards go part of the way in alleviating these aforementioned problems.

USPAP, despite being vague and watered down over the years, has improved the credibility of American appraisal reports and is also followed by many Canadian appraisers.

Internationally, IVSC (International Valuation Standards Council) has published a lengthy set of international valuation standards that would also improve valuation practice for commercial real estate and other asset classes, if followed, including a specific application standard for valuation of property interests for secured lending -- important for protecting the lending industry. It will be difficult to promulgate such standards, though, if IVSC continues to charge money for a book-length publication rather than publish it for free on the Internet. Unless there is a legal mandate or clients start insisting on valuations that meet these standards, I would not expect appraisers and valuers to go out of their way to buy this book. An appraiser declaring that his report has met these standards often faces the reality that the client does not know these standards or have access to them.

In the mean time, it would be a good thing if the commercial appraisers and valuers of the world could agree on a much briefer oath or manifesto that would protect the interests of those who rely on our reports, much like the Hippocratic Oath for physicians. You may say that I’m a dreamer, but I’m not the only one.
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Sunday, March 18, 2012

Appraisal of a Planned Oceanfront Community near Natal, Brazil

View to the south of the city of Natal and the Redinha Bridge opening up development opportunities in the beach towns north of Natal

Ponta Negra beach on the south side of Natal.

This assignment was to value a planned community (“Palm Springs”) already under construction next the beach town of Muriu, a northern suburb of Natal, a rapidly growing city of 800,000 and capital of the northern Brazilian state of Rio Grande do Norte. Muriu is a fishing village that has grown to include a “Millionaire’s Row” of residences owned by wealthy citizens of Natal.
Lobster boats of Muriu

The completion of Redinha bridge (see top photo) on 11/20/2007 opened up development opportunities in the towns north of Natal (including Muriu), and further highway improvements have been announced for the bridge and the northern part of Natal (as reported in the Tribuna do Norte 3/13/12) which will reduce commuting time from Muriu to Natal from 35 to 20 minutes.

What is significant about this is that Muriu will no longer just be a community of weekend and vacation homes; it can now also serve as a bedroom community for upper middle class commuters to Natal. Professional people will now be able to commute to high-paying jobs in the city while simultaneously living at the beach.

As this is my second valuation assignment in Brazil so far this year, this illustrates the dearth of local project financing available within Brazil, where banks charge high interest rates and developers are forced to turn to the U.S. and Europe for capital. A residential project such as this is typically initially funded by cash deposits of 10 to 15% of purchase price by the end buyers, which limits the available upfront money needed to build infrastructure. This can create a serious shortage of capital needed to build the necessary infrastructure.

Other cities making highway improvements towards beach cities have seen property booms in those beach cities. For example, in the Dominican Republic, the extension of the freeway from Santo Domingo to the airport and beyond created a building boom in the beach town of Juan Dolio and a new resort community known as Costa Blanca. Buyers have predominantly been local professionals from Santo Domingo.

These further highway improvements to Natal, the construction of a new stadium, as well as the opening in 2013 of a gigantic new airport, the largest in South America, are being done in preparation for the World Cup games in 2014. Natal will be one of the World Cup venues.

Consequently, in addition to demand from local buyers, there will also be increased exposure to tourists who may also turn into buyers.

The Principle of Ruinous Competition

As can be expected, once the bridge was completed, many developers announced their own residential development projects in the beach towns north of Natal. One developer even locked up commitments in 2009 from David Beckham for a soccer academy and former princess Sarah Ferguson for an equestrian center for a 1350-home project in Caraubas, 50 km north of Natal. Development has still not begun.

Although it is customary in Brazil to not start development until enough monies are collected through lot sales, the British developer of Palm Springs wanted to boost his credibility by starting development right away, particularly to counteract the distrust that Brazilians have developed against other British developers who sell lots and collect deposits for years without starting development. (My previous post on Brazil featured a project that had been selling lots for 6 years without yet starting development.)

There have been so many announced projects, but only two, including the one I am appraising, have started construction, and the other one, the Natal Ocean Club farther to the north, has suspended construction as a result of a new federal law preventing development within 100 yards of the shoreline, which is a big setback for some beach projects.
Subject property

If this particular developer’s strategy is correct, he should have the only construction-ready project when demand for homes north of Natal escalates after continuing road improvements, a major new airport, and escalating tourism to this area.

I am dusting off the old “subdivision development method”, a discounted cash flow methodology that can only safely be used when a residential project can be considered economically feasible (something I have not seen for a while), but a favorable confluence of events seem to support this project.
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