redemption halts in UK-based property funds

Over the past week or so, the boards of a number of UK property mutual funds have exercised the ability their charters give them to suspend shareholder redemptions.

What’s this all about?

The central issue is, of course, the “Leave” result of the Brexit vote.  This has two negative consequences for UK property.  The first is that property is a domestic sector, where holders whose base currency is the US$ or the € have felt the full brunt of the subsequent fall in sterling against those currencies.  The second is that although suddenly 12% cheaper to foreigners, it’s questionable whether offices or other commercial properties will retain their allure once the UK is on the outside of the EU.  Also, the central bank is predicting the vote will cause a mild recession, always a bad thing for property.  So bargain hunters haven’t yet appeared as buyers.

On balance,  a lot of people want to cash their shares in.

The second problem is endemic to property.  It’s not a particularly liquid sector.  Not only would you get a horrible price in a forced quick sale, it’s probably impossible to get the paperwork processed and a check in hand inside, say, a month.  Property funds–in fact, all mutual funds–try to safeguard against being overwhelmed by redemptions by keeping a percentage of assets (maybe 2% or 3%) in cash.  Funds also have credit lines they can draw against if need be.  But for property funds if holders of 10% of the outstanding shares all want to redeem at once that won’t be enough.

Initial redemptions can also create a self-reinforcing cycle.  Shareholders who initially had no intention to redeem may join the queue simply because they fear continuing withdrawal pressure will depress net asset value further.

The result is that the funds in question have been unable to meet the redemptions they’re experiencing.  They’ve been forced to suspend redemptions while they raise cash in a orderly way.

I don’t think the redemption window will be opening any time soon, although I’d imagine enterprising brokers have already set up a market to transact in these suspended shares, at a substantial discount to NAV, no doubt.


Lessons for the US?  More tomorrow.


what is a REIT?

real estate stocks

Many global stock markets contain vibrant real estate sectors.  Real estate investment companies, specializing  in holding either residential, or commercial or office real estate, are the most common.  But a number of markets also feature real estate development firms as important index constituents.  And, of course, hotel companies are almost ubiquitous.

Except for hotels, this hasn’t been the case in the US.


Real Estate Investment Trusts are a US concept, enabled by the Real Estate Investment Trust Act of 1960.  Since then, they’ve become the most common form of stock market ownership of apartment houses, malls and office buildings.

The REIT Act permits the creation of highly specialized corporations, analogous to mutual funds, that hold real estate.  In general terms, REITs must accept restrictions on the types of activity they can engage in and the requirement that they distribute to shareholders virtually all the profits they generate.  In return, REITs avoid having to pay tax at the corporate level on their earnings.  This means distributable income can be over 50% higher than a regular corporation would have!!

Specifically, to qualify as a REIT, a company must:

–hold at least 75% of its assets in real estate

–generate at least 75% of its income from real estate

–distribute to shareholders virtually all of that income

–maintain a diversified portfolio of assets, in much the same way that mutual funds are required to do

–keep an open share register, in that no one entity can own over 50% of the outstanding shares.

updates to the law

There are two:

The Tax Reform Act of 1986 allows REITs to provide their own property management and leasing services, rather than having to hire third parties to do this for them.

The REIT Modernization Act of 1999 allows REITs to have their own taxable subsidiaries to provide maintenance and other services to the properties they own.

The effect of these two modifications is to make REITs much more like publicly traded real estate investment companies available in Asian or European markets.  But REITs still retain the important advantage that they’re not subject to corporate tax.

appeal widening

The attractiveness of REITs in the US stock market has increased significantly in recent years.  Three main factors:

1.  investor preferences are changing

The aging of the Baby Boom means that this important segment of the investing population is increasingly interested in income generating investments.  REITs are a natural area of interest.

2.  mature companies are turning themselves into REITs

This is partly a response to the growing receptivity of investors to income vehicles.

Part is an intelligent response by corporate managements to the increasing maturity of their businesses.  The more common tack has been for aging companies to plow their cash flow back into new capacity or into acquisitions (both of which invariably generate only losses) in a foolish attempt to regenerate lost youth.  This may make the CEO feel good, but it almost always destroys shareholder value.

Part is also an increasing liberal interpretation by Washington of what constitutes real estate.

examples of “unconventional” REITs

Forest products company Weyerhaeuser and cell tower owner American Tower have already converted themselves into REITs.  Iron Mountain, which stores/disposes of corporate documents is in the process of following suit.

It seems to me the appeal of REIT conversion can only increase, especially since the companies doing so are receiving a strong positive reaction in their stock prices.




































































































































































































Hong Kong stocks–trying to turn up?

early signs from Hong Kong

Over the past couple of weeks, property stocks in Hong Kong are up sharply.  What makes this interesting is that in that market, property stocks and trading conglomerates (the successors to the old British opium companies) are the main ways of playing a cyclical upturn there.

economic policy stances

Describing the present situation in world markets in the most basic terms, we might say that the US and the EU are trying to deal with structural problems that are being made somewhat worse by a cyclical downturn in trade with emerging markets.

China, on the other hand, is dealing with a cyclical domestic downturn induced by government policy, which also is being made somewhat worse by the structural issues its Western trading partners are facing.

The US adopted an accommodative money policy years ago to address its problems, but appears unable so far to make any supportive fiscal changes.  The EU is very belatedly beginning to move on both fiscal and monetary fronts.

China has recently begun to reverse its restrictive interest rate regime, as its economy has begun to slow markedly.

China’s moves already making a positive difference?

That’s what the stocks of Hong Kong property developers appear to be saying.  It’s possible that property stocks are only moving in anticipation of future economic growth and not in reaction to the first stirrings of that growth itself.  My hunch is that the latter is the case, because I don’t read any world markets as being confident enough to act on policy changes alone.

Nevertheless, it’s still early days–too early for all but the most aggressive investors to act.  But the property stock movement does bear watching.  If Beijing’s policy efforts are already beginning to kindle even a mild cyclical upswing in the Chinese economy, there are two positive implications for equity investors.

–Hong Kong stocks, and especially pro-cyclical, China-related sectors like property, would continue their recent outperformance for a considerable time to come, and

–companies listed in other markets which have important China exposure and which have been languishing recently–luxury goods makers, for example–would likely become attractive investments again.

cyclical real estate rhythms: where we are now in the US

I recognize that the internet is making important structural changes in the shape of the real estate market in the US.

The most clearly visible to me is that e-commerce is fast making lots of retail space superfluous.  Many strip malls seem to me to be today’s equivalent of the old ghost towns of the Wild West that were all that remained after the local gold or silver mine petered out.  At the same time, fast broadband communication means that a small, but increasing, number of workers are able to live where it suits them rather than near a specific piece of corporate property.  Hence, the rising value of “vacation” or “destination” real estate.  And, of course, in mega-cities like New York we’re beginning to see the presence of wealthy mainland Chinese buyers of second homes.

the business cycle development pattern

Longer term influences aside, there is also a distinct business cycle rhythm to the real estate industry, which is what I want to write about today.  I think we’re at a cyclical turning point.

My experience comes from watching publicly traded real estate companies in the EU and in Asia, where–unlike the situation in the US–they can be important factors in stock market performance.

The pattern is easiest to see with urban office buildings, but it holds for residential and commercial real estate as well.

1.  As the economy begins to expand, demand for space in prime office locations begins to rise.  Vacancy rates shrink.  Price discounting disappears.  Rents begin to rise.

2.  As rents continue to move up, new construction projects are launched.  Some of these will be in prime locations.  But builders also know that as prime areas are filled up, businesses will be forced to consider secondary areas.  Land is usually more easily available there–and it’s cheaper, to boot.  So the secondary locations are a big thrust of new development.

3.   Companies in the central business district respond to higher rents by shipping some employees off to new, lower-cost office space that’s springing up in the secondary districts.  Firms that formerly occupied the secondary districts respond to redevelopment and higher rents there by locating further afield.

4.  Seeing these successive ripples of outward movement, speculators begin to anticipate the next iteration of the process.  They acquire land and perhaps build in anticipation of a tide of firms moving farther and farther from the central business district in search of more reasonable rents.

5.  The outward ripples stop–and the whole process shifts into reverse.  At some point, the combination of new space developed in the central district + existing tenants shifting increasing numbers of employees to cheaper locations causes an excess of prime office space in the center.  The economy may by this time be in cyclical slowdown, as well.  Landlords in the central business district begin to lower rents to lure customers back from secondary locations.  This kicks off successive waves of contraction, as lower rents and greater space availability move firms back to more convenient space.

6.  On the extreme periphery, speculators are left high and dry.  They’re stuck with raw land and, possibly, completed office buildings that they will be unable to use until–at the very earliest–when the next business cycle starts another outward pulse of development.

where we are now

The Wall Street Journal published a front-page article on Monday titled “US Farmers Reclaim Land From Developers.”  In it, the newspaper reports that large amounts of peripheral agricultural land–it cites parcels lying 30 miles and 65 miles outside of Phoenix–are being rebought by farmers out of foreclosure at small fractions of what development speculators paid for them a few years ago.

This is typically the last shoe to drop in the real estate cycle.

I don’t imagine that a new outward pulse will begin in the US anytime soon.  But it also seems to me that there’s virtually no potential for further bad economic news coming from the real estate sector.

walking around in Las Vegas last week

My wife and I went to San Francisco to see the Giants play two weeks ago.  Then we drove down the coast to Los Angeles to visit relatives.  And we stopped in Las Vegas for a day on the way home, just to see how the city looked compared with our last trip early in the year.

Over the years, I’ve learned that you have to be careful in drawing any firm conclusions about the hustle and bustle you see.  As I’ve already mentioned a long while ago in this blog, I once was in Caesars in Atlantic City at a time when the casino was packed to the gills.   (By the way, I’m not a big casino gambler myself.  I find it too much like work.  But the stocks are simple to analyze and usually generate huge amounts of cash flow.)

I called the company the next day and found out that their profits in Atlantic City were weaker than usual, not stronger.  A main set of doors had broken and no one could get in or out easily.  Few people were actually gambling; most were just stuck, and preventing fresh money from getting in.

Nevertheless, for what it’s worth:

–the city seemed to have far more foreign visitors than in January

–WYNN had a lot more casino patrons

–the Fashion Mall across the street was bustling

–the Bellagio seemed quieter; the visibly worn carpeting in retail areas hasn’t been replaced

–CityCenter appeared a lot quieter than in January

–I didn’t detect much difference with LVS

–every retail complex I saw had at least one vacancy, even WYNN;  CityCenter, understandably had the most empty space.


One of the odder aspects of my trip was the controversy that flared up last week over the yet-to-be-completed Harmon hotel in the CityCenter.  MGM is proposing to blow the structure up. (VegasInc has a comprehensive account).  It says the building is a potential hazard in an earthquake, because of construction defects.  Contractor Perini Building Co., which says MGM owes it $200 million+ for its work on the building, asserts any problems are design defects caused by MGM.   Just another day in the desert.

Las Vegas Sands–a bounceback in 2Q11

the results

In 2Q11, LVS had unusually bad luck in its gambling operations in Singapore and in Las Vegas.  That happens occasionally.  Give a properly run casino enough time, however, and the odds even out.  2Q11 was a more normal quarter for the company from an odds point of view.  Combine that with stunning growth in Singapore, and the result was revenue for LVS during 2Q11 of $2.35 billion, up 47% year on year.  Eps of $.54 weere more than triple the net during the comparable period of 2010, and 25% ahead of the Wall Street consensus.

the details

To my mind, the biggest story is Singapore, where EBITDA (earnings before interest, taxes, depreciation and amortization–I’m not a fan of this metric, but it’s the one this industry uses) was $405.4 million, up 42% quarter on quarter (up “only” 30% if you adjust 1Q11 results up to reflect normal “luck”)July may turn out to be the best month ever for the Marina Bay complex–which, strictly speaking, isn’t even finished.  Singapore is now by far the most valuable part of LVS.

I wasn’t floored by the Macau results, which–at EBITDA of $391.6 million–were up 27.5% year on year and about 4% quarter on quarter (market growth rates were 40%+ and 12%+, respectively, during those periods).  The issues are new capacity that opened recently right next to some of LVS’s operations, and the time it tales to recover from the actions of an inept CEO (since fired; he’s suing).  The Hong Kong stock market, however, regards the earnings report as very good news.  Sands China was up 10% in overnight in a flat market.

Las Vegas continues its slow recovery.  LVS posted EBITDA of $92 million in 2Q11 for Nevada operations. The lion’s share of the $30+ million quarter on quarter gain is a return of casino “luck” to normal.

$10 billion in debt no longer looks like such a big problem

Roughly speaking, $4 billion of that amount is borrowed against Singapore operations, $3 billion against Macau and $3 billion against the US.  LVS has just renegotiated the Macau debt to extend maturities and lower interest expense by close to $100 million yearly.  LVS will likely refinance Singapore soon, as well.

My back-of-the-envelope guess is that the LVS empire will generate $2.5 billion-$3 billion in cash flow over the coming 12 months.  Call it $2.8 billion.  Assume calls on that cash of $1 billion for capital expenditure plus $300 million for interest expense and $200 million for extra working capital.  That leaves $1.3 billion to go to debt repayment.  If LVS could manage twelve months without major capital outlays, borrowings would be more than cut in half in under three years.

Also, were LVS to sell 15% of Marina Bay in an IPO, I think it would raise enough to wipe out all its US debt.  I doubt this will happen until the property is more mature, but the possibility has to make lenders–and investors–feel more comfortable about LVS’ debt level.

And, of course, LVS has $3 billion or so in cash on its balance sheet.

the stock

A sum of the parts calculation is probably the most reasonable.

At yesterday’s closing price, LVS had a market capitalization of $33.8 billion.  The company’s share of publicly traded Sands China is worth $17 billion.  If we assume that Marina Bay would trade on the same valuation as Sands China–which could prove much too low–then that 100%-owned property is worth $24 billion.

This means Wall Street is valuing LVS’ US operations at -$7 billion.  This compares with a +$7 billion implied valuation for WYNN’s US operations and +$3.3 billion for those of heavily indebted MGM.

LVS shares (which I own–I may sell some today, though) would have to rise by about 30%, just for the implied valuation of its US properties to match those of MGM.  It would take a 20% rise just to get the value up to zero.

Why the disconnect?  I don’t know.  The former CEO of Sands China is suing, and claiming all sorts of improprieties by LVS management.  It’s also possible that some investors are uncomfortable with LVS’s debt–I know I have been–or don’t understand that the earnings disappointment in 1Q11 is just one of those things that happen in the gambling business.

the Flatotel and the Alex Hotel: a cautionary tale for investors

a free Wall Street Journal

I’m not a particular fan of News Corp, even though I will admit I was one of the first US-based holders of the stock–and a large one at that–in the mid-Eighties.  The Wall Street Journal is being delivered to my door every day this week as part of a campaign to gain new subscribers, however.  Yes, there’s a lot of fluff and it’s very US-centric.  But the paper is better than I remember.  To my surprise, I may end up subscribing.

That’s not my point today, though.

the underbelly of finance

The “Greater New York” section of yesterday’s paper has an interesting article in it that gives a glimpse at a part of the usually-hidden underbelly of finance.  It also shows some of the obstacles that investors in “deep value” or “distressed” assets routinely face.

Titled “Hotel Developer Must Check Out,” the article describes a recent foreclosure action in which a New York judge put two Manhattan hotels, the Flatotel and the Alex, into receivership.


The back story is about a former gold trader and a hotel developer who met in the gym and formed a hotel management company, Alexico.  Borrowing heavily from Anglo Irish Bank (the institution, incidentally, that played the pivotal role in crashing the entire Irish economy), the two started a number of high-end hotel and condominium projects. Then the great recession came.

Anglo Irish has since been nationalized.  As part of its restructuring, it sold the loans it made Flatotel and Alex–a face value of $258 million–to a consortium of US real estate management groups for maybe half that.  They went to court to force Alexico to turn over control of the two hotels.

That’s not the interesting part.

the interesting part

This is:

–the two hotels are losing money   They haven’t made payments on their debt, nor have they paid real estate taxes, for two years.  But they did manage to pay Alexico $570,000 in management fees during that period.

–in addition, the ailing hotels scraped together enough cash to lend $5.3 million to other parts of the (now crumbling) Alexico empire.

–why didn’t Alexico extract even more money from the two failing hotels, you may ask?  A cynic, meaning someone who’s seen this movie before, would say that what Alexico took was all the cash the hotels were generating.

–besides this, the plaintiffs in the case say the hotels’ financial records are a mess (what a surprise!). No elaboration, but I don’t think the issue is that the accountants spilled coffee on the books or that the entries are all mixed up and in the wrong places.  I interpret this as meaning there’s no way of knowing how much money came in the hotels’ doors or tracing where it went.  If so, there may be more money missing than the loans.

All of this is pretty standard fare.  But there’s typically more:

–were the hotels larger, we’d probably also be talking about their employee pension plan–who manages it?  did it too lend money to other parts of Alexico?

–if Alexico built the hotels instead of buying them, we’d likely also be asking about whether the structures are up to code, or if the construction company used lower-quality materials than specified in the contracts.

when the burden of proof shifts…

As a general rule, it’s a mistake in a situation like this to think either  1) that this is the first time the people involved have done something like this, or 2) that what you’ve discovered to date is everything they’ve done to the asset in question.

This is why it takes a certain mindset to navigate through the potential minefield of a distressed asset.  All in all, I’m happier being a growth stock investor and leaving this sort of analysis to someone else.