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

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

My assignment was to review a translated Korean language appraisal that had been ordered by a Korean court, in order for me to figure out the damages her brothers had to pay her for stealing part of her inheritance, and testify to this in a California court.

I had been a speaker at a conference sponsored by the Korean Association of Property Appraisers in Seoul in 2008, and was familiar with some of their valuation methods and the differences there are with U.S. valuation methods.

Two differences are:

Land and improvements are valued separately.  This is similarly done in Germany and by U.S. tax assessors, and I’m finding it increasingly necessary in Los Angeles County, where land values are spiraling upwards, calling into question the highest and best uses of many older properties.

Because Seoul is built out and there is a lack of land sales, The Minister of Land, Transport and Maritime Affairs also compiles a “Officially Announced Price System”. I often find that such price announcement systems fail to keep pace with changing market conditions, especially if created by a government bureaucracy.

The Government's computer-generated land valuations are overly general, too.  Theoretically, the appraiser should adjust land values for accessibility, size, and developability. This appraiser made no adjustments.

In this case no adjustment was made for a 4-story. 7736 square foot building that had no road access (see photo).  It was situated on a 241.3 square meter (2597 square feet) lot in Jongno-gu, which is one of the wards that compose the central business district of Seoul. The building itself is situated behind and obscured by a taller building and thus had no street access or visibility.

The appraiser stated land value to be 12,210,000 Korean won per square meter, equivalent to $10,912 per square meter or more than $1000 per square foot.  I have seen such land valuations in Manhattan, and since Seoul is a city of 10.2 million people with twice the population density as New York, I did not immediately doubt such a figure.

Nevertheless, the zoning for the site allowed only one extra story of height, and the site was already fully covered.  Accessible only by alley way, there would have to be an assemblage of adjacent parcels if any type of redevelopment could be done, but this is done commonly in Seoul if 80% of property owners consent to join a "redevelopment union".

Although this building was classified as an office building, its employees were more likely to be employed as seamstresses than office workers.  The lack of vehicular access limited this property’s highest and best use. The size of the lot, less than 2600 square feet, was only about half the size of a typical residential lot, which is not conducive to high-density redevelopment, and the space between buildings was so tight that I could not get a photograph of the whole building in one frame.

To find comparable sales and listings I turned to the auction houses which publish details of their real estate auctions.  They typically publish the original reserve price, which is based on appraised value, and then subsequent reserve prices which are discounted by 20% each month until they attract bidders.  The subject property itself had failed to attract bidders at two auctions and the reserve price for the next auction is now set at 64% of appraised value.

In the end, the client was able to get compensation from her brothers based on the original Korean appraisal.

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

Shameless Book Promotion

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

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

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

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

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

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

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

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

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

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

“Show me” – Harry Truman

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

“Trust, but verify” – Ronald Reagan

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

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

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

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

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

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

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

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

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

Appraisal in Roatan, Honduras

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

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

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

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

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

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

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

The Growing Worldwide Glut of Luxury Condos



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



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

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

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

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

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

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

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

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

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

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

 

 

 

 

Tier 3 Condo Towers in Shanghai

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

 

EB-5 MARKETING AT THE OVERSEAS PROPERTY AND IMMIGRATION EXHIBITION IN BEIJING, CHINA 警告通过美国的“区域中心EB-5签证中国投资房地产申请人”

It was in 2013 that this blog first started discussing the risks to foreign investors when investing in so-called “regional centers” approved by the US Citizenship and Immigration Services agency for the U.S. EB-5 Visa program.

A regional center is usually a private enterprise organized to pool invested funds from foreign investors seeking the EB-5 visa, the visa that grants permanent green cards to immigrants that invest a minimum of $500,000 in an enterprise that creates at least 10 permanent U.S. jobs.  The normal minimum is $1 million, but “targeted employment areas”, areas having unemployment greater than 50% above average, have that threshold reduced to $500,000.

Many investors have mistakenly believed that approval of a regional center by USCIS means approval of the soundness and integrity of the regional center.  The USCIS was never given the mandate or the resources to vet these regional centers, however.  Nor have they been given the authority to terminate regional centers for malfeasance, only for failure to submit paperwork on time.  According to Baidu Baike (a Chinese on-line encyclopedia), there were 5539 Chinese EB-5 investor lawsuits filed in U.S. courts just within the 18 months between February 2014 and August 2015, or more than 300 investor lawsuits per month. That’s a large number considering that only 10,000 EB-5 visas are allocated per year.

When first studying EB-5 regional centers, I cynically suspected that a lot of these EB-5 regional centers were founded by real estate developers who couldn’t find funding elsewhere -- turned down by all the banks. 

As I looked into the backgrounds of these regional center executives, however, I found that I had not been cynical enough.  Many have no real estate development experience and were instead underemployed immigration lawyers, securities salesmen and realtors appointing themselves as middlemen in search of worthy real estate projects.  At my first EB-5 conference, when I introduced myself as a commercial appraiser to regional center exhibitors, I was often asked if I knew of any projects that needed funding.  I said yes, all of the many projects that had been rejected by my lender clients, such as a proposed Biblical Theme Park to be built in a flooded Texas sand quarry.

Worse yet, when I conducted background checks on regional center executives, many had histories of civil liens and judgments against them, foreclosures, and even bankruptcies.  Background checks were not part of the USCIS vetting process in approving I-924 applications from prospective regional centers and their founders.  One of the regional centers represented at OPIE did not disclose to investors that the CEO had gone through bankruptcy 12 years ago, recently sold 20% of his regional center to a Chinese company (these are all investor funds) at about the same time he bought a $2.9 million power boat, and then went into default on his primary home loan last October.  Yet he is soliciting $443 million for a large luxury residential project.  What investor, knowing this, would trust their funds to such a man?

USCIS investigators were not trained to vet business enterprises wishing to operate regional centers; they traditionally investigate visa fraud, such as fraudulent marriages for green cards.

In the last 3 years the SEC (U.S. Securities and Exchange Commission) has been assisting the USCIS by investigating regional centers that violate U.S. securities laws, yet USCIS keeps on approving new regional centers faster and faster, with 824 approved regional centers as of today.  This surplus of regional centers will spell the ruin of many existing centers that can no longer find enough investors for worthy projects.

One of the first major actions by the SEC was against “A Chicago Convention Center” and founder Anjoo Sethi, described in my post http://www.internationalappraiser.com/2013/05/attempt-to-defraud-261-chinese.html.  If USCIS had had a proper vetting process, this 29-year-old pharmacy technician would have probably not been given the authority to take $156 million from investors to supervise construction of 5 hotels and a convention center.  His claim of 15 years of development experience would have been quickly derided.  No one in the U.S. thought to verify permits with the city of Chicago (it only takes one phone call) or verify hotel management contracts with the three major operators, including Starwood and Intercontinental Hotels Group. Instead, it was a rival exhibitor at a property exhibition in China who blew the whistle on Mr. Sethi.  In my own observations, fraudulent regional centers tell much bigger lies in China than in the U.S., and China is the source of 83.5% of EB-5 applicants. This was the reason I went to China. 

At this point, I think the most important issue to consider is how to repatriate the funds of thousands of foreign investors who have been defrauded.  The SEC is on the case, as is the FBI (Federal Bureau of Investigation), but justice is slow and meticulous, and there are hundreds of regional centers, with more added all the time without proper due diligence.  All that is required for regional center approval is an economic report from one of the econo-whore consulting firms. 

I have currently complained to the SEC about three dozen EB-5 regional centers.

 

Here are the red flags I have noticed in researching these regional centers:

 

1.       Fake mailing address.  If the regional center has no personnel at the advertised mailing address, how much confidence would you place in them?

2.       No mention of the persons managing the regional center.  Don’t you want to know who you’re entrusting your money to?

3.       No projects advertised.  Many times their web sites claim that U.S. Securities Laws prevents them from disclosing their projects within the U.S., but when I go overseas, I either see no projects or fake projects on their web sites.  EB-5 applicants should look for “shovel-ready” projects and not projects that do not even have development approvals.

4.       Unqualified executives.  If one wants to invest in a real estate development, the regional center should be managed by a successful real estate development company, not immigration lawyers, securities salesmen or realtors.

5.       Fake projects.  A phone call to the local planning office will disclose whether the development project is real and approved.

6.       False representation of success.  For instance, one regional center crows about all the Wal-Marts they’ve built, but these stores were built in 1992, long before the regional center existed. Claims that 100% of applicants have received green cards, particularly from regional centers only two years old, are very doubtful.

7.       Regional center executives who have not properly disclosed their unfavorable legal histories. I can do a $10 background check on a regional center executive and often find a history of 1) civil court judgments, 2) tax liens, 3) foreclosures and 4) bankruptcies.  If these events were not disclosed in the offering document, typically a PPM (Private Placement Memorandum), the regional center has violated the Securities Act of 1933.

 

PS: October 4, 2016 update

 

As a result of my Freedom of Information Act Request to USCIS, I have received names of all EB-5 regional centers that still exist and have obtained permanent visas for their investors.  There are 46 of them out of the now 863 regional centers in operation.  In other words, only about 5% of regional centers have fulfilled their purpose in getting their investors permanent visas.

 

Here is my assessment of the landscape of the 863 EB-5 regional centers:

 

20% are fraudulent

  5% are effective

75% are ineffective for various reasons:

 

1. They are too large in scope and will never become fully invested because they are competing for investors with 862 other regional centers.

2. The leaders are not qualified to create the jobs.  Many are opportunistic middlemen that founded a regional center before they even find a project to build or fund. They pay themselves salaries.

3. Some will not be able to prove that they created 10 jobs per investor.

 

 

Worried investors are welcome to contact me privately about concerns about their regional centers, as are their attorneys.  Feel free to contact me if you have been cheated.

 

 

On the Subject of Flipping Foreign Beach Lots for Profit

A failed Brazilian beach community visited in 2012. Notice that most lots are more than one kilometer from the beach.

 

I get occasional e-mails or phone calls by or about someone contemplating buying a vacant lot in a waterfront subdivision in Latin America or the Caribbean, and these would-be buyers have probably not read some of my older posts.

I recently received two inquiries related to Belize and Panama. Both inquiries related to oversized subdivisions (as large as 1000 lots), of which only a handful of homes have been built. Both would-be buyers, though, were not planning to relocate soon to these communities. One just wanted to flip. The other wanted to “buy before it’s too late”.

For several years, private lenders have sent me to appraise such planned communities in Costa Rica, Belize, Mexico, Brazil, Barbados, St. Maarten, the Bahamas, Jamaica, and Trinidad. The situations were approximately similar in that homebuilding or lot sales had stalled and the whole subdivision was reeling in debt, yet each community had glossy brochures and dazzling web sites. Sometimes there were many lots sales having occurred several years ago, but these were to flippers who put 20% down and got financing from the developer, as they sometimes disclosed in on-line investor forums. They often responded to advertisements such as “Own your own beachfront lot for only $200 per month!” Few homes were built compared to the number of lots sold.

Then, when buyers realized that their lots had declined in value by more than 20%, they stopped making payments, and the lots reverted back to the developer through foreclosure. Meanwhile, the developer may be still be advertising that his planned community is 70%+ sold. For some developers, this has become a racket: Collect the down payment and monthly payments, foreclose, and then start the selling process all over again while crowing about the number of lots sold.

In communities like these, I see nothing but falling land values. The developer is having to compete with lot owners who want to sell their own lots, which is a classic oversupply situation that only depresses lot values.

For those who bought lots with the intention of actually building and occupying them, they are also at risk of loss in value and loss of promised amenities. I have seen so many subdivisions which were advertised as gated communities with luxury amenities, but ended up with abandoned guardhouses and no security from outside intruders.

 

If you really want to live in “Paradise”, I would advise to buy in a community which is mostly built out, with actual homes built and occupied, and with a history of recent sales. If sales have stalled, some of the promised amenities, such as spas, clubhouses, and golf courses may not get built after all.

Also beware of marketing tricks. If the developer claims that “Phase One has already sold out!”, ask to see Phase One. Are there any homes built? I saw a situation in Brazil where there was no Phase One developed before they started advertising Phase Two. I saw a situation in North Carolina where all but one duplex in the sold out Phase One was a non-arm’s length sale between a partnership and its partners at the inflated price of $500,000. These looked like mobile homes on stilts. Most of the units had “For Sale” signs in front. Despite my warning, a client of mine went out of business lending $17 million on future phases. Even if homes are built, the subdivision can still fail if most of the homes are still empty.

If the advice to "buy before it's too late" comes from Ronan McMahon, consider the source and my previous post about him.  I have similar suspicions about Katherine Peddicord.

Flipping foreign properties is a dangerous sport, best left to clever local investors. And if you want to live in a new “foreign paradise” community, make sure that there are people actually living there.

Appraisal of a Resort near Victoria, British Columbia

This was an appraisal done for financial reporting purposes for a Chinese corporation that acquired the resort 2 years previously.

 

Chinese investors have already bid up the Vancouver housing market to prices unaffordable to most Canadians. I even have a Chinese friend who owns three Vancouver condos while he lives in the San Francisco Bay Area.

 

Some Chinese investors are now competing with Canadian investors for commercial real estate. Capitalization rates for British Columbia hotels have dropped by half since 2003 (from 12 to 14% to 6 to 8%).  The BC tourist industry has particularly benefited from the until-recent growing oil wealth of western Canada, particularly Alberta.

 

View from my room

 

The subject property is a 5-star bayside resort on Vancouver Island with a restaurant, bar, spa and marina. Guests were observed to be middle-aged couples, presumably Canadian (who else would vacation in Canada in March?), and the ambiance of the resort makes it a good place for “second honeymoons”. Management is by Canadian professionals. In the two years under new ownership, net operating income has increased by almost 5%, with higher gains in gross revenues, occupancy and operating profit.

 

What is unique about this resort, though, is that only 30% of revenues come from room revenues. 53.5% of revenues come from food and beverage operations, which for most hotels normally have low profit margins or are even loss leaders. In this case, though, the profit margin on food and beverage operations exceeded 28%; the food was excellent, and the hotel often serves as a venue for weddings and other community events. The spa contributed another 12% of revenues and the marina contributed about 6% (but was the department with the highest profit margins).

 

I found it unusual that I was hired by an appraisal firm that was hired by another appraisal firm. Perhaps the Hong Kong Stock Exchange is intent upon truly independent valuations, which I would applaud. On this blog I have been critical in the past about the Singapore Stock Exchange, which seems to let corporations hire any appraisal whore that they choose.

 

The financial statements seemed to conform to the new Uniform System of Accounts for the Lodging Industry. I was presented, however, with excerpts from another appraisal done by an unknown appraiser as of the same valuation date. This appraiser was of the opinion that the hotel had appreciated 48% in value in the previous two years, despite only a 5% increase in NOI. I had no details of the appraiser’s income approach, which is the approach I generally rely on for profitable hotels, but I suspect that this appraiser did not adjust the income and expense statements for “reserves for replacement” for FF&E (furniture, fixtures and equipment) and other building components, which I generally see estimated at between 3 and 5.5% of gross revenues for hotels. The general manager of the subject hotel even estimated 4% “CapEx” for the subject resort.

 

The other appraiser’s sales comparison approach was an abomination. The simplest way of comparing hotels is on a “price per room” basis, but this works best for limited service motels which earn their revenues substantially from room rentals. All of the comparable sales prices he used were inflated and incorrect, which would have been easily verified by going on-line to British Columbia’s free land registry web site: http://evaluebc.bcassessment.ca , where real estate sales are publicly recorded. Although publicly recorded sales of BC hotels have been as high as $275,000 per room in the last two years, this appraiser made awkward adjustments (up to 100%) to justify a value of $533,333 per room, without considering that this resort’s restaurant, bar, spa and marina operations accounted for much of the value of the resort.

International investment heats up in the renewable energy sector

Solar-paneled roof of National Stadium in Kaohsiung, Taiwan, producing 1 megawatt of electricity

My appraisal practice has changed significantly in the last year. Whereas I spent the last few years visiting struggling or proposed luxury home subdivisions, hotels, tourist projects and golf communities in foreign countries, my clients have reduced their appetite for such risky ventures. Nowadays more than half of my work involves the valuation of land for solar photovoltaic energy production, AKA solar farms.

There seems to be a great appetite for cross-border investments in renewable energy infrastructure projects. Such projects are able to attract capital from investors not needing high returns, but focused rather on steady, long-term yield from contractual government or utility company payments that reimburse them. Renewable energy infrastructure seems a safe and easy investment compared to foreign casinos and luxury vacation resorts.

Each week brings one or more announcements of cross-border renewable energy deals. Last week, Swiss-owned Adiant Capital Partners sold a 37 megawatt UK solar farm to UK-owned Foresight Group. Canadian-owned Northland Power has announced a $177 million IPO for wind farms in Canada and Germany. Australian fund AMP Capital is entering the Japanese renewables market. The Blackstone Group (U.S.) has announced that its second energy fund, $4.5 billion in size, focusing on renewable energy assets worldwide, has been oversubscribed.

There is construction risk, of course, but many transactions are also structured as sale-leasebacks of the land the renewable energy projects are built on. And management risk of renewable energy infrastructure is nothing compared to commercial real estate, unless you have Homer Simpson pushing the buttons.

Renewable energy infrastructure is now so mainstream that Google and Apple are investing, including a Norwegian-owned project in Utah that I recently appraised, in which Google will be partially financing the development of a $157 million solar plant.

Another example of a multinational solar farm venture I evaluated was a duo of Ecuadorian solar farms to be developed by a German manufacturer financed by private money from the U.S. The deal fell through because the German CEO didn’t understand that his firm had to own or buy the properties they would be mortgaging and that licensing and power purchase agreements had to be finalized before the investor would commit funds.

Valuation methods for solar farm land

The approach of choice is the sales comparison approach, which works well in California due to the large number of publicly recorded transactions. Solar farm appraisers are not always so lucky to find verifiable sales, though, in foreign countries and “non-disclosure” U.S. states (such as Utah, New Mexico and Texas) and sometimes must turn to a land residual approach to valuation, in which land values are imputed by valuing the completed project and then subtracting development costs and expected entrepreneurial profit. The recent reduction in development costs has justified rising values of land with power purchase agreements and public approvals.

The role of technology in increasing solar farm land values

The last few years have seen escalating land values in the U.S. southwest for land which has secured conditional or special use permits for solar photovoltaic energy production as well as power purchase agreements with utility companies. The reason for this land price appreciation has been because the value of such land is a residual of the cost to develop it for solar PV use, and the cost of PV technology has fallen more than 50% in the last several years, but rates for electrical usage have not fallen.

Much of the deflation in solar PV development costs is the result of cheaper technology being imported from Taiwan and China. I have recently been on a research trip to Taiwan, for example, to study their solar PV and wind power innovations.

There may be a temporary halt in falling solar PV development costs, however, as the U.S. government in February has imposed “antidumping” penalties on Chinese and Taiwanese manufacturers. The antidumping duty on Taiwanese solar cells is now 20%, and the new duties on Chinese solar panels will range from 39 to 52%.

Wind-powered park at Cijin Beach, Kaohsiung, Taiwan

Also, with the price of oil falling more than 50% in the last year, there may be less public pressure to subsidize renewable energy projects. These combined forces may temporarily stop the tide of rising values for solar farm and wind farm land.

This may be a temporary hiccup, though, in a long-term trend of renewable energy sources to replace fossil fuel technologies as our predominant power production technology, as production costs are likely to continue to fall as technology advances. Compare these advances to shale oil hydraulic fracturing technology, which is only more expensive than conventional on-shore drilling. Ten years from now, the world of energy production is likely to be quite different than today.

Solar-powered golf course in Chiba prefecture of Japan, near Inba, as seen from my plane flight

Wind-powered business park in Kamisu, Ibaraki Prefecture, as seen from my plane flight

What is the Future for Bakken Real Estate?

 
 Dunn County "man camp" operated by Civeo, itself laying off 45% of staff

North Dakota and Canada's Bakken region can be considered a true boomtown economy, and with booms there are often busts based on changing economic circumstances.

The precipitous fall in oil prices is likely to whipsaw the Bakken economy, as shale oil production costs anywhere from $55 to $85 per barrel, and at this moment, West Texas Intermediate oil is trading on NYMEX for $47.88 per barrel. However, this figure represents the value of West Texas oil, not Bakken oil, which must be transported much farther than West Texas oil. The added transportation costs range from $11 to $19 per barrel of oil, meaning that the value of Bakken oil is much lower than for WTI.

This morning, the price offered at the pipeline for Williston Basin Sweet oil was just $31.69 per barrel and the price offered for Williston Basin Sour (meaning high sulfur content) was $22.58 per barrel.

Drilling activity in North Dakota has already been declining, with the number of drilling rigs declining 23% so far since this oil boom’s peak. The reason this number has not declined more is because much of the oil being produced at the moment is "hedged" or pre-sold at yesterday's prices. If current prices stay the same or decline more, the real bust might not occur for a few more months. That will be when layoffs accelerate and the man camps, motels and RV parks start experiencing significant vacancies.

The effect on real estate will be significant, and I have personally witnessed a similar collapse while working as an appraiser in Houston, Texas, from 1984 to 1987, when I lost my job in the Texas real estate collapse after oil prices fell to $9 per barrel.

Most affected will be the value of land previously considered to have development potential. There has been a proliferation of Bakken-area land parcels being advertised as ideal for business park, RV park or hotel development, at prices up to $200,000 per acre. Most of these are still raw, undeveloped land, and their highest and best use just may be a return to farming or ranching. It may be common to see commercial land values falling by more than 90% as highest and best use changes from commercial to agricultural.

RV parks will also be in jeopardy, as they typically house temporary oil workers who may be first to go as layoffs continue. Other “man camps” are already in trouble. Man camp operator Civeo, featured in the above photo, has announced layoffs for 45% of its total worldwide staff and saw its stock price plunge 50% yesterday. Its stock price is now $3.11 per share, an 89% decrease in the last year.

The lodging industry will also be severely impacted, as many hotel rooms were built to accommodate the boom in temporary workers, and there will be a consequent oversupply of rooms.

PS: Bakken update, January 14, 2015

The number of active drilling wells in North Dakota has fallen to 158 as of today, over 26% below the peak of the Bakken oil boom. The offering price for Williston Basin Sweet is $29.44 per barrel and $20.33 for Williston Basin Sour, representing further declines of 7% and 10% respectively in the last week.

PPS: Bakken update, March 5, 2015

The number of active drilling wells in North Dakota has fallen to 113 as of today, 47% below the peak of the Bakken oil boom. The offering price for Williston Basin Sweet at the Plains pipeline has risen to $35.19 per barrel for Williston Basin Sweet and $26.08 for Williston Basin Sour.

What this means is that Bakken oil producers are receiving 20 to 28% more for their oil in the last 2 months, as North Dakota drilling activity has dropped by 30% in the same time period and inventories shrink.

The consequences for the real estate sector will be negative.  Since the peak of Bakken drilling activity in mid-2012, the number of active drilling rigs has declined from 215 to 113, a drop of 47.5%.  Considering that each drilling rig employs 100 to 125 workers, this represents job losses of about 10,000 to 12,000 workers, workers who were living in motels and RV parks, and some who might have been renting apartments or even searching for a home to buy.  Despite the improvement in the price willing to be paid for Bakken oil, these benefits will go to the oil producers and not the real estate market.

PPS: Bakken update, March 16, 2015

The number of active drilling wells in North Dakota has fallen to 111 as of today, 48% below the peak of the Bakken oil boom. The offering price for Williston Basin Sweet at the Plains pipeline has plummeted to $28.44 per barrel for Williston Basin Sweet and $19.33 for Williston Basin Sour.

The most active driller in Bakken is Whiting Petroleum (WLL).  It put itself up for sale last week and the stock popped up to $40 per share after reporting interested buyers, at which time I sold this stock short. With current assets and a book value of property, plant and equipment (probably above market value) adding up to $13 billion, and liabilities of $8.3 billion, current market capitalization of $6.4 billion as of this moment seems at least 50% too high.

Related story:  http://on.wsj.com/1BNWrPY

PPS: Bakken update, March 27, 2015

The number of active drilling wells in North Dakota has fallen to 97 as of today, 55% below the peak of the Bakken oil boom. The offering price for Williston Basin Sweet at the Plains pipeline has increased to $32.44 per barrel for Williston Basin Sweet and $23.33 for Williston Basin Sour.

The most active driller in Bakken is Whiting Petroleum (WLL).  I sold this stock short 2 weeks ago at $40 per share and it closed today at $30.50 per share, for a personal gain of 23.75% in 2 weeks.

PPS: Bakken update, July 15, 2015

The number of active drilling wells in North Dakota has fallen to 73 as of today, 66% below the peak of the Bakken oil boom. The Plains All American Pipeline is no longer publishing offering prices for Bakken crude, but oil prices in general are higher compared to March, and the offering price for Nebraska Intermediate, closest in proximity to Bakken, is $39.50 per barrel today.  This is better news for oil companies, but bad news for Bakken-area real estate, as a two-thirds reduction in drilling rigs means that some oil workers might be moving out of state. The effect on employment could be muted, though, because up until this year, many workers were working double shifts so that they could earn six-figure incomes.  Still, this hinders their ability to pay the inflated rents of yesterday.