parking lots

It’s Black Friday, a shopping day that will likely reveal how widely wallets will be oepned this holiday season.  It’s also Recovery Day, from Thanksgiving overeating.

 

For no particular reason, other than I saw an article in Wednesday’s Wall Street Journal  in which a hedge fund manager reveals he has “discovered” parking lots as an investment form, I’m going to write about them.

There’s really nothing new about parking lots as an investment.  From forever, real estate companies-and enterprising individuals–have bought raw land on the edge of towns in the hope that urban expansion will reach their purchases, making them quantum leaps more valuable.  While they wait, the owners generate cash flow by making their purchases into parking lots.

In today’s time of gentrifying neglected parts of big cities, buying existing parking lots in poor neighborhoods can serve the same function.

For what it’s worth, real estate investors in the US used to do the same edge-of-town thing on a much larger scale–and with notably less success–by converting big speculative tracts into amusement parks.

The biggest drawback I can see to parking lot ownership is the fact that it involves controlling huge numbers of relatively small cash transactions.  Keeping track of them is one issue.  Making sure all the receipts are recorded is another.  A third is that, again from forever, parking lots have been a standard way for the underworld to launder the proceeds of their  illegal enterprises–making them look wildly more profitable that they actually are.

I’m not sure the hedge fund guy from two days ago realizes what he’s getting into.

REITs when interest rates are rising

Finally, to the question of REITs (Real Estate Investment Trusts).

A REIT is a specialized type of corporation that accepts restrictions on the kind of business it can do and limits to how concentrated its ownership structure can be.  It must also distribute virtually all its profits to shareholders.  In return it gets an exemption from corporate income tax.  It’s basically the same legal structure as mutual funds or ETFs.

Traditionally, REITs have concentrated on owning income-generating real estate.  But they are also allowed to to develop and manage new projects, provided they do so to hold as part of their portfolios instead of to resell.

Because they must distribute basically all of their profits, and to the degree that their property development efforts are small relative to their overall asset size, REITs look an awful lot like bonds.  That is to say, their main attraction is their relatively steady income.  Yes, they hold tangible assets of a type that should not be badly affected by inflation.  But current holders, I think, view them as bond substitutes.

As I suggested in Monday’s post, that’s bad in a time of rising interest rates.  Both newly-issued bonds–and eventually cash as well–become increasingly attractive as lower-risk substitutes.  This is the reason REITs have underperformed the S&P by about 5 percentage points so far this month, and by 9 points since the end of September.  I don’t think we’ve yet reached the back half of this game.

How can an investor fight the negative influence of interest rate rises in the REIT sector?   …by finding REITs that look as much as they can like stocks.  That is, by finding REITs that are able to achieve earnings–that therefore distributable income–growth.

This means finding REITs that can raise rents steadily or whose development of new properties is large relative to their current asset size.

 

Trump’s taxes

Over the weekend, the New York Times published an article that contains copies of parts of Donald and Marla Trump’s 1995 income tax filings.  The pages, mailed to a Times reporter in September and verified as genuine by the accountant who prepared them, contain two items of note:

 

–during that year, the Trumps had income of about $9 million.  That was more than offset by a loss of $15.8 million generated from “rental real estate, royalties, partnerships, S corporations, trusts…”–which I take as being tax loopholes designed for the real estate industry.  If we assume that this is par for the course, it would mean that the Trumps typically pay no federal or state income tax.

 

–the Trumps also show that as of that year they had accumulated other losses totaling a stunning $909 million.   This figure is presumably the cumulative result of Donald Trump’s efforts as an investor.  Two points:

—tax losses have a current economic value, which deteriorates as time passes.  In this case, the value in 1995 of the Trump’s loss was about $350 million, and was shrinking in economic worth by, let’s say, $30 million per year.  Logically, the best course of action would have been for the Trumps to use the loss by selling, the sooner the better, something they owned and had a profit on.  The fact that they did not suggests they didn’t have any investment gains at that time–or that they used what gains they had to whittle the loss figure down to $909 million.

—Donald Trump was born into a wealthy real estate family.  He entered the family business with the advice and support of his successful father.  Falling interest rates + the development of New York City as a world financial center made the 1980s a golden age for real estate investing in the region the Trump family had expertise.  Yet the Trump 1995 tax returns suggest that on a net basis Donald not only made no profit during a time when real estate was like a license to print money; instead, he lost nearly a billion dollars.

In a recent Forbes article, John Griffin, a finance professor at the University of Texas/Austin examines Donald Trump’s investing career using publicly available data, both independent estimates and figures self-reported by Trump.  Prof. Griffin concludes that Mr. Trump has made only about half the profits of a typical real estate investor (about 40%, taking the self-reported figures), while taking on a higher than average level of risk.  Mr. Griffin concludes, ” Donald Trump is obviously a skillful presenter and a talented entertainer, but in terms of his investment skills, he is a clear underperformer.”  To my mind, the mammoth loss shown in the 1995 Trump tax return suggests that a less favorable assessment may be warranted.

 

 

 

real estate, a new S&P sector

To any professional investor from abroad, one of the oddities of the S&P 500 and other domestic indices is the relative absence of real estate and construction from them–despite the vast expanse of land in the US and the importance of the sector to the domestic economy.

This situation may be partially one of choice–that large real estate entities in the US have no trouble obtaining bank finance and, because of this, elect to remain private.  It’s also one of the myopia of index makers like S&P, however, which did not allow real estate investment trusts (REITs), the main corporate form of publicly traded real estate in the US, into its flagship S&P 500, until not much more than a decade ago.   Starting in 2001, REITs and other real estate companies have been included, but have been buried in the Financials sector.

a new sector

In the middle of next month, real estate will become truly visible in the S&P 500 for the first time, as the S&P creates an 11th sector to house them separately.

The new categorization would seem at first blush to be little more than paper shuffling, or an opportunity for the S&P to sell new index information.  I think it will have more than symbolic significance, though, both for property companies and for the residual Financials sector (mostly banks and brokers).  For the first time, investment professionals in the US will be forced to explicitly consider in the analysis of their investment performance the effect of their decisions about property and about banks/brokers as separate issues.

In other words, property will be hard to ignore.

I think the change will ultimately raise the level of knowledge about, and interest in, property stocks by American professionals to the level that’s common in the rest of the world.  If I’m correct, it will provide an extra cushion of support for REITs, which until now have been mostly supported by individual investors.  And–who knows?–it may mean that large family-controlled real estate companies will begin to consider public listing, raising the profile of the new sector further.